Tuesday, December 1, 2015

Monetary Policy & Tools of Monetary policy (CAIIB - Advanced Bank Management)

Monetary Policy is the process by which the Government, Central Bank controls
i. The money supply
ii. Availability of money and
iii. Cost of money or rate of interest.

Monetary policy is referred to as either being an expansionary policy or a contractionary policy.
An expansionary policy increases the total supply of money in the economy. This is used to combat unemployment in a recession by lowering interest rates.
A contradictory policy decreases the total money supply. This is used to combat inflation by raising the interest rates.

 Tools of Monetary policy

  1. Bank Rate.
  2. Cash Reserve Ratio 
  3. Statutory Liquidity Ratio 
  4. Market Stabilization Scheme 
  5. Repo Rate 
  6. Reverse Repo Rate 
  7. Open Market Operations

Bank Rate: It is also referred as Discount rate, is the rate of interest which a central bank charges on the loans and advances that it extends to commercial banks and other financial intermediaries.
Changes in the Bank Rate are often used by Central bank to control the money supply. 
The structure of interest rates is administered by RBI.

Cash Reserve Ratio (CRR): The present banking system is called a “Fractional Reserve Banking System, as the banks are required to keep only a fraction of their deposit liabilities in the form of liquid cash with the central bank for ensuring Safety and liquidity of deposits.
CRR was introduced in 1950 primarily as a measure to ensure safety and liquidity of bank deposits.

Statutory Liquidity Ration (SLR): SLR refers to the amount that all banks requires maintaining in cash or in the form of Gold or approved securities.
Approved securities mean dated securities, government bonds, and share of different companies.
The SLR is determined as % of Total Demand and Time Liabilities.