Apr-04-2014

Monetary policy theory

Monetary policy current: Urjit Patel
Banking sector theory:
Evolution
Bank vs NBFC
Banking sector current: New bank licenses;
Mahila Bank


Financial intermediaries
Barter => Double coincidence of wants
Money => circular flow of income
Financial intermediaries
Banking institutions
Non-banking institutions

Quantitative/ General/Indirect
1. Reserve Ratios
2. OMO: Open market op.
3. Policy Rate=> inflation,
deflation




1. Margin / LTV
2. Consumer Credit control /
Downpayment
3. Rationing
4. Moral Suasion
5. Direct Action
Monetary Policy: Instruments?
Qualitative/Selective/Direct
Nationalization: high reserve ratio
Deposit Example
s
Time Deposit FDRD
Demand Deposit CASA
Net Demand and Time
Liabilities (NDTL)
+100 cr.
NBFC cannot accept Demand
Deposit
CRR, SLR computed on NDTL

Nationalization: high reserve ratio: CRR
Deposit Examples
Time Deposit FDRD
Demand Deposit CASA
Net Demand and
Time Liabilities
(NDTL)
+100 cr.
Reserve
CRR (min 3%) (-) 15 [no profit]
Cash Reserve Ratio
Both sch. & non
Penalty
No profit. Except 1999.
Right now 4%
Nationalization: high reserve ratio SLR
Deposit Examples
Time Deposit FDRD
Demand Deposit CASA
Net Demand and Time
Liabilities (NDTL)
+100 cr.
Reserve
CRR (min 3%) (-) 15 [no profit]
SLR (min 25%) (-) 40 [some profit]
Money left with bank =45
Statutory liquidity Ratio
All banks (sch, Non-sch.)
Cash, gold, RBI approved
securities
Right now 23%

Nationalization: high reserve ratio (PSL)
Deposit Examples
Time Deposit FDRD
Demand Deposit CASA
Net Demand and Time
Liabilities (NDTL)
+100 cr.
Reserve
CRR (min 3%) (-) 15 [no profit]
SLR (min 25%) (-) 40 [some profit]
Money left with bank =45
PSL (40%) =45 x 0.4=18
Left for normal borrowers =45-18=27 cr.
Priority sector lending
40% of net credit
Yearly
jain
Inflation (upward price Movement)
RBI raises SLR, CRR
Bank have less money left.
People can borrow less
Low output
Low employment
Low income
Low demand
Low price level
RBI decreases SLR, CRR
Banks are left with more money
People can borrow more.
Monetary Policy: Cyclic fluctuation
(Reserve)
Deflation (downward)
Inflation (upward price Movement)
RBI sells securities from Open
Market
Bank buy => less money left.
People can borrow less
Low investment, expansion
Low employment
Low income
Low demand
Low price level
RBI buys securities from Open
Market
Banks sell to RBI => more money
People can borrow more.
Monetary Policy: Cyclic fluctuation
(OMO)
Deflation (downward)
MCQ (2013)
In context of Indian Economy, Open Market Operation refers
to
1. Borrowing by scheduled banks from RBI
2. Lending by commercial banks to industries and trade
3. Purchase and sale of government securities by the RBI
4. None of Above
(similar qs. In GS Manual)
1. Skip 2. Attempt 3. Mark n Review
Inflation (upward price Movement)
Policy rate=>increase
Banks borrow less
People borrow less
Low investment, expansion
Low employment
Low income
Low demand
Low price level
Policy rate=>decrease
Expansion of credit.
Monetary Policy: Cyclic fluctuation
Deflation (downward)
Bank Rate
When banks borrow long term funds from RBI. Theyve to pay this
much interest rate.
Bank rate= 9%
Collateral: nothing. (no Government security.)
Not the main tool to control money supply these days.
LAF is the main tool.
Why Bank rate?
Linked with penal rates:
If CRR, SLR not maintained.
Penalty= (Bank rate + 3%); 5%
LAF: Liquidity Adjustment Facility
From 2000
Repo and Reverse Repo





Collateral? = Government security.
Short term loans.
Repo When banks borrow from RBI, they pay this much
interest rate. 8%
Reverse
Repo
When banks deposit money in RBI, they earn this much
interest rate. 8-1=7%
Repo (cannot use SLR securities)
Marginal Standing Facility (can use SLR
securities)
LAF (Repo)
Minimum 5 cr
All clients eligible
1. Central & State Government
2. Banks (commercial, regional
rural banks, cooperative
banks)
3. Non-banking financial
institutions etc.
1 cr.
Only scheduled commercial
banks can bid.

Whats the difference?
MSF
LAF (Repo)
Bank cannot use SLR quota
securities
No limit. Borrow according to
your securities.
R%
Can use
Maximum 2% NTDL.


R+1%
Whats the difference?
MSF
Reverse Repo
Reverse repo rate = it is interest rate paid by RBI to its clients for
short term loans.
Central Government
State Government
Banks (commercial, regional rural banks, cooperative banks)
Non-banking financial institutions.
Collateral: government securities

2011: RR = Repo 1% (100 basis points).
28
th
Jan 2014: Repo = 8%. Reverse repo =8-1=7%

Inflation (upward price Movement)
Policy rates=>increase
Banks borrow less
People borrow less
Low investment, expansion
Low employment
Low income
Low demand
Low price level
Policy rates=>decrease
Expansion of credit.
Monetary Policy: Cyclic fluctuation
Deflation (downward)
How does Repo affects economy?
How does Policy rate affects economy?
Monetary Policy: limitations (Developing-countries)
1. People dont have many investment alternatives.
Commercial banks have high deposits.
2. Unorganized money market; Shroff; financial
inclusion
3. Monsoon uncertainty, cyclone, flood, draughts
4. Crude oil, gold import
5. Fiscal deficit; public borrowing
6. subsidy leakage, Black money, underground
economy

Repo: 7.75=>8%
MSF: Repo + 1%: 9%
Reverse Repo: Repo 1%=7%
CRR: 4%
SLR: 23%
Policy review
Earlier 45 days
2 months x 6
WPI (-food fuel): increased. Therefore
weve increased the repo rate.
Disinflationary path.
Further tightening=unlikely.
If inflation is reduced faster, well
reduce the rates.
CAD likely to reduce.


Monetary Policy: 28
th
Jan
Time CAD as %GDP
2012-13 4.8
2013-14 2.5
Quantitative/ General/Indirect
1. Reserve Ratios (CRR, SLR)
2. OMO: Open market op.
3. Policy rate=> inflation,
deflation


Monetary Policy: Instruments?
Qualitative/Selective/Direct
Margin requirements / LTV
Gold loan LTV: 60%=>75%
Loans against Securities
(shares/bonds)
Recession=> 65%=>85%
Selective/Direct

Monetary Policy: Qualitative=> Margin
Deflation
Downpayment: 30%=>10%
Reduce each installment:
5000 x 10 => 1000 x 50
Selective, Direct
Commercial vehicle
Monetary Policy: Qualitative: Consumer
Credit
Ceiling on total loans in each
sector.
Planned economy
PSL: 40% =>60%

Selective, Direct
Monetary Policy: Qualitative: Rationing
Moral Suasion
Monetary Policy: Qualitative
Direct Action
Quantitative/ General/Indirect
1. OMO: Open market op.
2. Reserve Ratios
3. Policy Rate=> inflation,
deflation




1. Margin / LTV (Akshay)
2. Consumer Credit /
Downpayment (Nano)
3. Rationing (Stalin)
4. Moral Suasion
5. Direct Action
Monetary Policy: Instruments?
Qualitative/Selective/Direct
Mock Qs.
MCQ (2012)
RBI Acts as bankers bank. This would imply which of the following?
1. Other banks retain their deposits with RBI
2. RBI lends funds to commercial banks in the times of need.
3. RBI advises commercial banks on monetary matters.
Correct Statement
A. Only 2 and 3
B. Only 1 and 2
C. Only 1 and 3
D. 1, 2 and 3.

1. Skip 2. Attempt 3. Mark n Review
MCQ (2012)
RBI Acts as bankers bank. This would imply which of the following?
1. (CRR) Other banks retain their deposits with RBI.
2. RBI lends funds to commercial banks in the times of need.
3. RBI advises commercial banks on monetary matters.
Correct Statement
A. Only 2 and 3
B. Only 1 and 2
C. Only 1 and 3
D. 1, 2 and 3.

1. Skip 2. Attempt 3. Mark n Review
MCQ (2012)
RBI Acts as bankers bank. This would imply which of the following?
1. (CRR) Other banks retain their deposits with RBI.
2. (Repo) RBI lends funds to commercial banks in the times of need.
3. RBI advises commercial banks on monetary matters.
Correct Statement
A. Only 2 and 3
B. Only 1 and 2
C. Only 1 and 3
D. 1, 2 and 3.

1. Skip 2. Attempt 3. Mark n Review
MCQ (2012)
RBI Acts as bankers bank. This would imply which of the following?
1. (CRR) Other banks retain their deposits with RBI.
2. (Repo) RBI lends funds to commercial banks in the times of need.
3. (Moral Suasion) RBI advises commercial banks on monetary
matters.
Correct Statement
A. Only 2 and 3
B. Only 1 and 2
C. Only 1 and 3
D. 1, 2 and 3 (Test series A, Q75, Ans.D)

1. Skip 2. Attempt 3. Mark n Review
Which of the following measures would result in an increase in the
money supply in economy? (2012)
1. Purchase of government securities from public by central bank
2. Deposit of currency in commercial banks by the public
3. Borrowing by government from the central bank.
4. Sale of government securities to the public by central bank.
Answer choice
A. Only 1
B. 2 and 4
C. 1 and 3 (Test series A, Q77, Ans.C)
D. 2, 3 and 4


1. Skip 2. Attempt 3. Mark n Review
Which of the following measures would result in an increase in the
money supply in economy? (2012)
1. Purchase of government securities from public by central bank
2. Deposit of currency in commercial banks by the public
3. Borrowing by government from the central bank.
4. Sale of government securities to the public by central bank.
Answer choice
A. Only 1
B. 2 and 4
C. 1 and 3 (Test series A, Q77, Ans.C)
D. 2, 3 and 4


Homework /Assignment
Banking
NCERT Class 12 (Macro
Economics)
Ch. 3 Money & Banking: Supply of
money, Functions of RBI
Ramesh Singh:
12 Banking

Mock Questions: Arihant, Disha,
GS Manual

Inflation
Ramesh Singh:
7: inflation and business cycle.
Interval