MONETARY POLICY

MEANING

A bank is a financial institution that provides banking and other

financial services to their customers. A bank is generally understood
as an institution which provides fundamental banking services such
as accepting deposits and providing loans. There are also
nonbanking institutions that provide certain banking services
without meeting the legal definition of a bank.

Banks are a subset of the financial services industry. A banking

system also referred as a system provided by the bank which offers
cash management services for customers, reporting the
transactions of their accounts and portfolios, throughout the day.
The banking system in India should not only be hassle free but it
should be able to meet the new challenges posed by the technology
and any other external and internal factors. For the past three
decades, India’s banking system has several outstanding
achievements to its credit. The Banks are the main participants of
the financial system in India. The Banking sector offers several
facilities and opportunities to their customers. All the banks
safeguards the money and valuables and provide loans, credit, and
payment services, such as checking accounts, money orders, and
cashier’s cheques. The banks also offer investment and insurance
products. As a variety of models for cooperation and integration
among finance industries have emerged, some of the traditional
distinctions between banks, insurance companies, and securities
firms have diminished. In spite of these changes, banks continue to
maintain and perform their primary role—accepting deposits and
lending funds from these deposits.

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DEFINITION

According to Section 5(b) of The Banking Regulation

Act, 1949 defines Banking as:-

“The accepting, for the purpose of lending or investment, of

deposits of money from the public, repayable on demand or

otherwise, and withdrawable by cheque, draft, or order or
otherwise.

Banking Regulation Act, 1949 (sec. 5(c)), has defined

the banking company as, “Banking Company means any company
which transacts business of banking in India”.

HISTORY

The first bank in India, though

conservative, was established in 1786.
From 1786 till today, the journey of
Indian Banking System can be
segregated into three distinct phases:

 Early phase of Indian banks,

from 1786 to 1969
 Nationalization of banks and the
banking sector reforms, from
1969 to 1991
 New phase of Indian banking system, with the reforms after
1991

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Phase 1

The first bank in India, the General Bank of India, was set up in
1786. Bank of Hindustan and Bengal Bank followed. The East India
Company established Bank of Bengal (1809), Bank of Bombay
(1840), and Bank of Madras (1843) as independent units and called
them Presidency banks. These three banks were amalgamated in
1920 and the Imperial Bank of India, a bank of private
shareholders, mostly Europeans, was established. Allahabad Bank
was established, exclusively by Indians, in 1865. Punjab National
Bank was set up in 1894 with headquarters in Lahore. Between
1906 and 1913, Bank of India, Central Bank of India, Bank of
Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set
up. The Reserve Bank of India came in 1935.

During the first phase, the growth was very slow and banks
also experienced periodic failures between 1913 and 1948. There
were approximately 1,100 banks, mostly small. To streamline the
functioning and activities of commercial banks, the Government of
India came up with the Banking Companies Act, 1949, which was
later changed to the Banking Regulation Act, 1949 as per amending
Act of 1965 (Act No. 23 of 1965). The Reserve Bank of India (RBI)
was vested with extensive powers for the supervision of banking in
India as the Central banking authority. During those days, the
general public had lesser confidence in banks. As an aftermath,
deposit mobilization was slow. Moreover, the savings bank facility
provided by the Postal department was comparatively safer, and
funds were largely given to traders.

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Phase 2

The government took major initiatives in banking sector

reforms after Independence. In 1955, it nationalized the Imperial
Bank of India and started offering extensive banking facilities,
especially in rural and semi-urban areas. The government
constituted the State Bank of India to act as the principal agent of
the RBI and to handle banking transactions of the Union
government and state governments all over the country. Seven
banks owned by the Princely states were nationalized in 1959 and
they became subsidiaries of the State Bank of India. In 1969, 14
commercial banks in the country were nationalized. In the second
phase of banking sector reforms, seven more banks were
nationalized in 1980. With this, 80 percent of the banking sector in
India came under the government ownership.

Phase 3

This phase has introduced many more products and facilities in

the banking sector as part of the reforms process. In 1991, under
the chairmanship of M Narasimham, a committee was set up, which
worked for the liberalization of banking practices. Now, the country
is flooded with foreign banks and their ATM stations. Efforts are
being put to give a satisfactory service to customers. Phone banking
and net banking are introduced. The entire system became more
convenient and swift. Time is given importance in all money
transactions. The financial system of India has shown a great deal
of resilience

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BANKING IN INDIA

In India, banks are segregated in different groups. Each group

has its own benefits and limitations in operations. Each has its own
dedicated target market. A few of them work in the rural sector only
while others in both rural as well as urban. Many banks are catering
in cities only. Some banks are of Indian origin and some are foreign
players.

Banks in India can be classified into:

• Public Sector Banks

• Private Sector Banks

• Cooperative Banks

• Regional Rural Banks

• Foreign Banks

One aspect to be noted is the increasing number of foreign banks in

India. The RBI has shown certain interest to involve more foreign
banks. This step has paved the way for a few more foreign banks to
start business in India.

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CHARACTERISTICS / FEATURES OF A BANK

1. Dealing in Money: Bank is a financial institution which deals

with other people's money i.e. money given by depositors.

2. Individual / Firm / Company: A bank may be a person, firm

or a company. A banking company means a company which is in
the business of banking.

3. Acceptance of Deposit: A bank accepts money from the people

in the form of deposits which are usually repayable on demand or
after the expiry of a fixed period. It gives safety to the deposits of
its customers. It also acts as a custodian of funds of its customers.

4. Giving Advances: A bank lends out money in the form of loans

to those who require it for different purposes.

5. Payment and Withdrawal: A bank provides easy payment and

withdrawal facility to its customers in the form of cheques and
drafts; it also brings bank money in circulation. This money is in the
form of cheques, drafts, etc.

6. Agency and Utility Services: A bank provides various banking

facilities to its customers. They include general utility services and
agency services.

7. Profit and Service Orientation: A bank is a profit seeking

institution having service oriented approach.

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8. Ever increasing Functions: Banking is an evolutionary concept.

There is continuous expansion and diversification as regards the
functions, services and activities of a bank.

9. Connecting Link: A bank acts as a connecting link between

borrowers and lenders of money. Banks collect money from those
who have surplus money and give the same to those who are in
need of money.

10. Banking Business: A bank's main activity should be to do

business of banking which should not be subsidiary to any other
business.

11. Name Identity: A bank should always add the word "bank" to
its name to enable people to know that it is a bank and that it is
dealing in money.

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RESERVE BANK OF INDIA

The central bank of the country is the Reserve Bank of India

(RBI). It was established in April 1935 with a share capital of Rs. 5
crores on the basis of the recommendations of the Hilton Young
Commission. The share capital was divided into shares of Rs. 100
each fully paid which was entirely owned by private shareholders in
the beginning. The Government held shares of nominal value of Rs.
2, 20,000.

Reserve Bank of India was nationalised in the year 1949. The

general superintendence and direction of the Bank is entrusted to
Central Board of Directors of 20 members, the Governor and four
Deputy Governors, one Government official from the Ministry of
Finance, ten nominated Directors by the Government to give
representation to important elements in the economic life of the
country, and four nominated Directors by the Central Government
to represent the four local Boards with the headquarters at Mumbai,
Kolkata, Chennai and New Delhi. Local Boards consist of five
members each Central Government appointed for a term of four
years to represent territorial and economic interests and the
interests of co-operative and indigenous banks.

The Reserve Bank of India Act, 1934 was commenced on April

1, 1935. The Act, 1934 (II of 1934) provides the statutory basis of
the functioning of the Bank.

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The Bank was constituted for the need of following:

 To regulate the issue of banknotes

 To maintain reserves with a view to securing monetary
stability and
 To operate the credit and currency system of the country to
its advantage.

FUNCTIONS OF RBI

 Issue of Currency Notes

 Banker to The Government
 Banker’s bank And Lender of Last Resort
 Controller of Credit
 Exchange control And Custodian of Foreign Reserve
 Collection and Publication Of Data
 Regulatory and Supervisory Functions
 Clearing House Functions

 Development and Promotional Functions

Of this the main function of RBI is to control the credit or

supply of money in the market credit created by banks. The
RBI through its various quantitative and qualitative techniques
regulates total supply of money and bank credit in the interest
of economy. RBI pumps in money during busy season and
withdraws money during slack season.

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INTRODUCTION TO MONETARY POLICY

Monetary policy is the process by which the monetary

authority of a country controls the supply of money, often targeting
a rate of interest for the purpose of promoting economic growth and
stability. The official goals usually include relatively stable prices
and low unemployment. Monetary theory provides insight into how
to craft optimal monetary policy. It is referred to as either being
expansionary or contractionary, where an expansionary policy
increases the total supply of money in the economy more rapidly
than usual, and contractionary policy expands the money supply
more slowly than usual or even shrinks it. Expansionary policy is
traditionally used to try to combat unemployment in a recession by
lowering interest rates in the hope that easy credit will entice
businesses into expanding. Contractionary policy is intended to
slow inflation in hopes of avoiding the resulting distortions and
deterioration of asset values.

Monetary Policy Influences On:

Monetary policy influences the SUPPLYOF MONEY AND RATE OF

INTEREST in order to stabilize the economy at full employment or
near full employment.

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MEANING
Monetary policy is the process by which the government,
central bank, or monetary authority of a country controls (i) the
supply of money, (ii) availability of money, and (iii) cost of money
or rate of interest to attain a set of objectives oriented towards the
growth and stability of the economy.

Monetary policy rests on the relationship between the rates of

interest in an economy, that is the price at which money can be
borrowed, and the total supply of money. Monetary policy uses a
variety of tools to control one or both of these, to influence
outcomes like economic growth, inflation, exchange rates with other
currencies and unemployment. Where currency is under a monopoly
of issuance, or where there is a regulated system of issuing
currency through banks which are tied to a central bank, the
monetary authority has the ability to alter the money supply and
thus influence the interest rate (to achieve policy goals).

It is important for policymakers to make credible

announcements. If private agents (consumers and firms) believe
that policymakers are committed to lowering inflation, they will
anticipate future prices to be lower than otherwise. If an employee
expects prices to be high in the future, he or she will draw up a
wage contract with a high wage to match these prices. Hence, the
expectation of lower wages is reflected in wage-setting behavior
between employees and employers (lower wages since prices are
expected to be lower) and since wages are in fact lower there is
no demand pull inflation because employees are receiving a smaller
wage and there is no cost push inflation because employers are
paying out less in wages.

To achieve this low level of inflation, policymakers must

have credible announcements; that is, private agents must believe
that these announcements will reflect actual future policy. If an
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announcement about low-level inflation targets is made but not

believed by private agents, wage-setting will anticipate high-level
inflation and so wages will be higher and inflation will rise. A high
wage will increase a consumer's demand (demand pull inflation)
and a firm's costs (cost push inflation), so inflation rises. Hence, if a
policymaker's announcements regarding monetary policy are not
credible, policy will not have the desired effect.

If policymakers believe that private agents anticipate low

inflation, they have an incentive to adopt an expansionist monetary
policy (where the marginal benefit of increasing economic output
outweighs the marginal cost of inflation); however, assuming
private agents have rational expectations, they know that
policymakers have this incentive. Hence, private agents know that if
they anticipate low inflation, an expansionist policy will be adopted
that causes a rise in inflation. Consequently, (unless policymakers
can make their announcement of low inflation credible), private
agents expect high inflation. This anticipation is fulfilled through
adaptive expectation (wage-setting behavior);so, there is higher
inflation (without the benefit of increased output). Hence, unless
credible announcements can be made, expansionary monetary
policy will fail.

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DEFINITION

Definition of 'Monetary Policy'

The actions of a central bank, currency board or other

regulatory committee that determine the size and rate of growth of
the money supply, which in turn affects interest rates. Monetary
policy is maintained through actions such as increasing the interest
rate, or changing the amount of money banks need to keep in the
vault (bank reserves).

Monetary Policy as per U.S Government,

In the United States, the Federal Reserve is in charge of

monetary policy. Monetary policy is one of the ways that the
U.S. government attempts to control the economy. If the money
supply grows too fast, the rate of inflation will increase; if the
growth of the money supply is slowed too much, then economic
growth may also slow. In general, the U.S. sets inflation targets
that are meant to maintain a steady inflation of 2% to 3%.

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FEATURES OF MONETARY POLICY

1. Active Policy: Before the advent of planning in India in 1951,

the monetary policy of the Reserve Bank was a passive, cheap
and easy policy. It means that Reserve Bank did not use the
measures of monetary policy to regulate the economy. For
example from 1935 to 1951, the bank rate remained stable at
3%. But since 1951, the Reserve Bank has been following an
active monetary policy. It has been using all the measures of
credit control.

2. Overall Expansion: An important feature of Reserve Bank’s

monetary policy is that of overall expansion of money supply. In
the words of S.L.N. Sinha, The Reserve Bank’s responsibility is
not merely one of credit restriction. In a growing economy there
has to be continuous expansion of money supply and bank credit
and the central bank has the duty to see that legitimate credit
requirements are met’. In fact, the overall, trend of money
supply has been one of the expansions along with an almost
continuous rise in price level.

3. Seasonal Variations: The monetary policy is characterized

by the changing behavior of busy and slack seasons. These
seasons are tied to the agricultural seasons. In the busy season
there is an expansion of funds on account of the seasonal needs
of financing production, and inventory building of agricultural
commodities. On the other hand, the slack season is
characterized by the contraction of funds due to the return flow.
The main reason behind this changing pattern is the requirement
of additional funds by the industrial sector. Thus, during busy

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season the Reserve Bank adopts an expansionary credit policy

and tightens the liquidity pressures during the slack season.

4. Tight and Dear Monetary Policy: In order to restrain

inflation the Reserve Bank has often adopted a tight and dear
monetary policy. A tight monetary policy implies that the rate of
growth of money supply is lowered. A dear money policy refers
to increase in bank rate. This increase in bank rate leads to an
increase in the interest rates charged by the banks.

5. Investment and Saving Oriented: The monetary policy

adopted by the Reserve Bank is both investment and saving
oriented. To encourage investment, adequate funds were made
available for productive purposes at reasonable rates of interest.
The Reserve Bank has also kept the interest on deposits at a
reasonable rate to attract savings.

6. Imbalance in Credit Allocation: The monetary policy is

biased towards industrial sector. Agriculture does not get the
required institutional finances. Consequently, it has to depend
upon money lenders to a considerable extent for its credit needs.
The agricultural sector has to pay high rate of interest and even
then does not get required amount of capital. A large part of
funds flows to large industries. Even small scale industries suffer
from the inadequacy of finances. Thus monetary policy has
resulted in imbalances in credit allocation.

7. Wide Range of Methods of Credit Control: The

Reserve Bank has used a wide range of instruments of credit
control. It has adopted all the measures of quantitative and
qualitative credit controls to meet the needs of a complex and
varying economic situation.
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OBJECTIVES OF MONETARY POLICY

The main objective of monetary policy in India is ‘growth with

stability’. Monetary Management regulates availability, cost and use
of money and credit. It also brings institutional changes in the
financial sector of the economy. Following are the main objectives
of monetary policy in India:-

1. RAPID ECONOMIC GROWTH:-

It is the most important objective of
monetary policy. The monetary policy can
influence the economic growth by controlling
real interest rate and its resultant impact on
the investment.
Example: if RBI opts for a cheap or easy
credit policy by reducing interest rates, the
investment level in the economy can be encouraged.

2. PRICE STABILITY:-
All the economics suffer from inflation and deflation; it can also be
called as price stability. Both are
harmful to economy. Thus monetary
policy having an objective of price
stability tries to keep the value of
money stable. It helps in reducing the
income and wealth inequalities.

Example: - when the economy suffers

from recession the monetary policy
should be an ‘easy money policy’ but when there is inflationary
situation there should be ‘dear money policy’.

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3. EXCHANGE RATE STABILITY:-

Exchange rate stability should be there into the economy to bring in

confidence to other countries for trading purpose. However, to
maintain exchange rate stability, internal price stability needs to be
maintained. A fall in exchange rate is
caused by an excess demand for
foreign exchange over its supply. In
other words, if demand for imports is
greater than the demand for exports.
The exchange rate will rise at the
international value of the currency will
fall. To maintain stability in the
international value of currency, a restrictive monetary policy will
have to be adopted to bring about a reduction in money supply and
the imports.

4. BALANCE OF PAYMENT EQUILIBRIUM:-

Many developing countries like India

suffer from the disequilibrium in the
balance of payment. The RBI through
its monetary policy tries to maintain
equilibrium in the balance of payment.

•Aspects:

1. BOP surplus. (Excess money supply in the domestic economy).

2. BOP deficit. (Stringency of money).

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5. FULL EMPLOYMENT:-

These days, the most important objective of monetary policy is

attainment of full employment with
consideration of inflation. The
objectives of price and exchange
rate stability have been given a
secondary importance these days.
The policy of full employment can be
pursued through monetary
measures as they can help in
achieving and maintaining the rates
of savings and investment at a level,
which would ensure full employment. For this, monetary policy may
help in raising the aggregate rate of savings and proper
channelization of savings to desirable directions of investments.
Several monetary measures can be adopted for raising the level of
savings. The rates of interest may be increased and banking
facilities may be expanded. Similarly, for boosting investment, bank
credit may be offered for investment. Besides, monetary
instruments may be, used to ensure that the banking system
contributes to financing the planned public investments. For
example, in India SLR is used to ensure that a good part of the
savings mobilized by the banking system are invested in
Government securities and approved securities for financing vital
investment projects.
•Example: if monetary policy is expansionary then credit supply can
be encouraged. It could help in creating more jobs in different
sectors of the economy.

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 MONETARY POLICY

6. NEUTRALITY OF MONEY:-

Economists such as Wicksted, Robertson have always considered

money as a passive factor. According to them, money should only
play a role of medium of exchange and not more than that.
Therefore monetary policy should regulate the supply of money.
The change in money supply creates monetary disequilibrium. Thus
monetary policy has to regulate the supply of money and neutralize
the effect of monetary expansion. However this objective of
monetary policy is always criticized on the ground that if money
supply is kept constant then it would be difficult to attain price
stability.

7. EQUAL INCOME DISTRIBUTION:-

Monetary policy can make special

provisions for the neglect supply such
as agriculture, small scale industries;
village industries etc. and provide them
cheaper credit for longer term. Thus
monetary policy helps in reducing
economic inequalities among different
sections of society.

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TYPES OF MONETARY POLICY

In practice, to implement any type of monetary policy the

main tool used is modifying the amount of base money in
circulation. The monetary authority does this by buying or selling
financial assets (usually government obligations). These open
market operations change either the amount of money or its
liquidity (if less liquid forms of money are bought or sold).
The multiplier effect of fractional reserve banking amplifies the
effects of these actions.

Constant market transactions by the monetary authority

modify the supply of currency and this impacts other market
variables such as short term interest rates and the exchange rate.

The different types of policy are also called monetary

regimes, in parallel to exchange rate regimes. A fixed exchange
rate is also an exchange rate regime; The Gold standard results in a
relatively fixed regime towards the currency of other countries on
the gold standard and a floating regime towards those that are not.
Targeting inflation, the price level or other monetary aggregates
implies floating exchange rate unless the management of the
relevant foreign currencies is tracking exactly the same variables
(such as a harmonized consumer price index).

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Inflation Targeting
Under this policy approach the
target is to keep inflation, under a
particular definition such
as Consumer Price Index, within a
desired range.

The inflation target is achieved

through periodic adjustments to the Central Bank interest
rate target. The interest rate used is generally the interbank rate at
which banks lend to each other overnight for cash flow purposes.
Depending on the country this particular interest rate might be
called the cash rate or something similar.

The interest rate target is maintained for a specific duration

using open market operations. Typically the duration that the
interest rate target is kept constant will vary between months and
years. This interest rate target is usually reviewed on a monthly or
quarterly basis by a policy committee.

Changes to the interest rate target are made in response to

various market indicators in an attempt to forecast economic trends
and in so doing keep the market on track towards achieving the
defined inflation target. For example, one simple method of inflation
targeting called the Taylor rule adjusts the interest rate in response
to changes in the inflation rate and the output gap. The rule was
proposed by John B. Taylor of Stanford University.

Price Level Targeting

Price level targeting is similar to inflation targeting except that

growth in one year over or under the long term price level target is
offset in subsequent years such that a targeted price-level is
reached over time, e.g. five years, giving more certainty about
future price increases to consumers. Uncertainty in price levels can

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create uncertainty around price and wage setting activity for firms
and workers, and undermines any information that can be gained
from relative prices, as it is more difficult for firms to determine if a
change in the price of a good or service is because of inflation or
other factors, such as an increase in the efficiency of factors of
production, if inflation is high and volatile. An increase
in inflation also leads to a decrease in the demand for money, as it
reduces the incentive to hold money and increases transaction
costs and shoe leather costs.

Monetary Aggregates
In the 1980s, several countries used an approach based on a
constant growth in the money supply. This approach was refined to
include different classes of money and credit (M0, M1 etc.). In the
USA this approach to monetary policy was discontinued with the
selection of Alan Greenspan as Fed Chairman. This approach is also
sometimes called monetarism.

While most monetary policy focuses on a price signal of one

form or another, this approach is focused on monetary quantities.

Fixed Exchange Rate:

This policy is based on maintaining

a fixed exchange rate with a foreign
currency. There are varying degrees of
fixed exchange rates, which can be
ranked in relation to how rigid the fixed
exchange rate is with the anchor nation.

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 MONETARY POLICY

Under a system of fiat fixed rates, the local government or

monetary authority declares a fixed exchange rate but does not
actively buy or sell currency to maintain the rate. Instead, the rate
is enforced by non-convertibility measures (e.g. capital controls,
import/export licenses, etc.). In this case there is a black market
exchange rate where the currency trades at its market/unofficial
rate.

Under a system of fixed-convertibility, currency is bought and

sold by the central bank or monetary authority on a daily basis to
achieve the target exchange rate. This target rate may be a fixed
level or a fixed band within which the exchange rate may fluctuate
until the monetary authority intervenes to buy or sell as necessary
to maintain the exchange rate within the band. (In this case, the
fixed exchange rate with a fixed level can be seen as a special case
of the fixed exchange rate with bands where the bands are set to
zero.)

These policies often abdicate monetary policy to the foreign

monetary authority or government as monetary policy in the
pegging nation must align with monetary policy in the anchor nation
to maintain the exchange rate. The degree to which local monetary
policy becomes dependent on the anchor nation depends on factors
such as capital mobility, openness, credit channels and other
economic factors.

Gold Standard:

The gold standard is a system under

which the price of the national currency
is measured in units of gold bars and is
kept constant by the government's
promise to buy or sell gold at a fixed

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 MONETARY POLICY

price in terms of the base currency. The gold standard might be

regarded as a special case of "fixed exchange rate" policy, or as a
special type of commodity price level targeting.

The minimal gold standard would be a long-term commitment to

tighten monetary policy enough to prevent the price of gold from
permanently rising above parity. A full gold standard would be a
commitment to sell unlimited amounts of gold at parity and
maintain a reserve of gold sufficient to redeem the entire monetary
base.

Today this type of monetary policy is no longer used by any

country, although the gold standard was widely used across the
world between the mid-19th century through 1971. Its major
advantages were simplicity and transparency.

The gold standard induces deflation, as the economy usually grows

faster than the supply of gold. When an economy grows faster than
its money supply, the same amount of money is used to execute a
larger number of transactions. The only way to make this possible is
to lower the nominal cost of each transaction, which means that
prices of goods and services fall, and each unit of money increases
in value. Absent precautionary measures, deflation would tend to
increase the ratio of the real value of nominal debts to physical
assets over time.

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INSTRUMENTS OF MONETARY POLICY

The instruments of monetary policy are devise which are used

by the monetary authority in order to attain some predetermined
objectives. There are two types of instruments of the monetary
policy as shown below:

(A) Quantitative Instruments or General Tools: -

The Quantitative Instruments are also known as the General

Tools of monetary policy. These tools are related to the Quantity or
Volume of the money. The Quantitative Tools of credit control are
also called as General Tools for credit control. These methods
maintain and control the total quantity or volume of credit or money
supply in the economy. These methods are indirect in nature and
are employed for influencing the quantity of credit in the country.
The general tool of credit control comprises of following
instruments.

Bank Rate Policy (BRP)

The Bank Rate Policy (BRP) is a very important technique used in

the monetary policy for influencing the volume or the quantity of
the credit in a country. The bank rate refers to rate at which the
central bank (i.e. RBI) rediscounts bills and provides advance to
commercial banks against approved securities. It is "the standard
rate at which the bank is prepared to buy or rediscount bills of
exchange or other commercial paper eligible for purchase under the
RBI Act". The Bank Rate affects the actual availability and the cost
of the credit. Any change in the bank rate necessarily brings out a

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resultant change in the cost of credit available to commercial banks.

If the RBI increases the bank rate than it reduce the volume of
commercial banks borrowing from the RBI. It deters banks from
further credit expansion as it becomes a more costly affair. On the
other hand, if the RBI reduces the bank rate, borrowing for
commercial banks will be easy and cheaper. This will boost the
credit creation. Thus any change in the bank rate is normally
associated with the resulting changes in the lending rate and in the
market rate of interest.

Open Market Operation (OMO)

The open market operation refers to the purchase and/or sale of

short term and long term securities by the RBI in the open market.
This is very effective and popular instrument of the monetary policy.
The OMO is used to wipe out shortage of money in the money
market, to influence the term and structure of the interest rate and
to stabilize the market for government securities, etc. It is
important to understand the working of the OMO. If the RBI sells
securities in an open market, commercial banks and private
individuals buy it. This reduces the existing money supply as money
gets transferred from commercial banks to the RBI. Contrary to this
when the RBI buys the securities from commercial banks in the
open market, commercial banks sell it and gets back the money
they had invested in them. Obviously the stock of money in the
economy increases. This way when the RBI enters in the OMO
transactions, the actual stock of money gets changed. Normally
during the inflation period in order to reduce the purchasing power,
the RBI sells securities and during the recession or depression
phase she buys securities and makes more money available in the
economy through the banking system.

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 MONETARY POLICY

Variation in the Reserve Ratios (VRR)

The Commercial Banks have to keep a certain proportion of

their total assets in the form of Cash Reserves. Some part of
these cash reserves are their total assets in the form of cash. Apart
of these cash reserves are also to be kept with the RBI for the
purpose of maintaining liquidity and controlling credit in an
economy. These reserve ratios are named as Cash Reserve Ratio
(CRR) and a Statutory Liquidity Ratio (SLR). The CRR refers to
some percentage of commercial bank's net demand and time
liabilities which commercial banks have to maintain with the central
bank and SLR refers to some percent of reserves to be maintained
in the form of gold or foreign
securities. In India the CRR by law
remains in between 3-15 percent
while the SLR remains in between
25-40 percent of bank reserves.
Any change in the VRR (i.e. CRR +
SLR) brings out a change in
commercial banks reserves
positions. Thus by varying VRR
commercial banks’ lending capacity
can be affected. Changes in the VRR helps in bringing changes in
the cash reserves of commercial banks and thus it can affect the
banks credit creation multiplier. RBI increases VRR during the
inflation to reduce the purchasing power and credit creation. But
during the recession or depression it lowers the VRR making
more cash reserves available for credit expansion.

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 MONETARY POLICY

(B) Qualitative Instruments or Selective Tools

The Qualitative Instruments are also known as the Selective

Tools of monetary policy. These tools are not directed towards the
quality of credit or the use of the credit. They are used for
discriminating between different uses of credit. It can be
discrimination favoring export over import or essential over non-
essential credit supply. This method can have influence over the
lender and borrower of the credit. The Selective Tools of credit
control comprises of following instruments:-

CEILING ON CREDIT:
The RBI has imposed ceiling on bank credit against the security
of certain commodity. This imposes a limit on the amount of credit
to different sectors like hire-purchase and installment sale of
consumer goods. Under this method the down payment, installment
amount, loan duration, etc. is fixed in advance. Such measures
ensure financial discipline in the banking sector.

FIXING MARGIN REQUIREMENTS:

The margin refers to the "proportion of the loan amount which is
not financed by the bank". Or in other words, it is that part of a loan
which a borrower has to raise in order to get finance for his
purpose. A change in a margin implies a change in the loan size.
This method is used to encourage credit supply for the needy sector
and discourage it for other non-necessary sectors. This can be done
by increasing margin for the non-necessary sectors and by reducing
it for other needy sectors. Example: - If the RBI feels that more
credit supply should be allocated to agriculture sector, then it will
reduce the margin and even 85-90 percent loan can be given.

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 MONETARY POLICY

PUBLICITY:
This is yet another method of selective credit control. Through it
Central Bank (RBI) publishes various reports stating what is good
and what is bad in the system. This published information can help
commercial banks to direct credit supply in the desired sectors.
Through its weekly and monthly bulletins, the information is made
public and banks can use it for attaining goals of monetary policy.

CREDIT RATIONING:
Central Bank fixes credit amount to be granted. Credit is rationed
by limiting the amount available for each commercial bank. This
method controls even bill rediscounting. For certain purpose, upper
limit of credit can be fixed and banks are told to stick to this limit.
This can help in lowering banks credit exposure to unwanted
sectors.

MORAL SUASION:
It implies to pressure exerted by the RBI on the Indian banking
system without any strict action for compliance of the rules. It is a
suggestion to banks. It helps in restraining credit during inflationary
periods. Commercial banks are informed about the expectations of
the central bank through a monetary policy. Under moral suasion
central banks can issue directives, guidelines and suggestions for
commercial banks regarding reducing credit supply for speculative
purposes.

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 MONETARY POLICY

CONTROL THROUGH DIRECTIVES:

Under this method the central bank issue frequent directives to
commercial banks. These directives guide commercial banks in
framing their lending policy. Through a directive the central bank
can influence credit structures, supply of credit to certain limit for a
specific purpose. The RBI issues directives to commercial banks for
not lending loans to speculative sector such as securities, etc.
beyond a certain limit.

DIRECT ACTION:
Under this method the RBI can impose an action against a bank. If
certain banks are not adhering to the RBI's directives, the RBI may
refuse to rediscount their bills and securities. Secondly, RBI may
refuse credit supply to those banks whose borrowings are in excess
to their capital. Central bank can penalize a bank by changing some
rates. At last it can even put a ban on a particular bank if it does
not follow its directives and work against the objectives of the
monetary policy.

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 MONETARY POLICY

MONETARY POLICY TOOLS

 DIRECT POLICY TOOLS

These tools are used to establish limits on interest rates, credit

and lending. These include direct credit control, direct interest rate
control and direct lending to banks as lender of last resort, but they
are rarely used in the implementation of monetary policy by the
Bank.

 Interest rate controls – The Bank has the power to announce

the minimum and maximum rates of interest and other charges
that commercial banks may impose for specific types of loans,
advances or other credits and pay on deposits. Currently, the Bank
does not set any interest rate levied by commercial banks except
for the minimum interest rate payable on savings deposits. The
Bank has opted not to use this as a tool of monetary policy but to
let market forces determine interest rate.

 Credit controls – The Bank has the power to control the volume,
terms and conditions of commercial bank credit, including
installment credit extended through loans, advances or
investments. The Bank has not exercised such controls in its
implementation of monetary policy.

 Lending to commercial banks – The Bank may provide credit,

backed by collateral, to commercial banks to meet their short-
term liquidity needs as lender of last resort. The interest is set at a
punitive rate to encourage banks to manage their liquidity
efficiently.

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 MONETARY POLICY

 INDIRECT POLICY TOOLS

Used more widely than direct tools, indirect policy tools seek to
alter liquidity conditions. While the use of reserve requirements has
been the traditional monetary tool of choice, more recently, the
Bank shifted towards the use of open market operations to manage
liquidity in the financial system and to signal its policy stance.

 Reserve requirements – The Bank uses reserve requirements to

limit the amount of funds that commercial banks can use to make
loans to its customers. Commercial banks are required to hold a
proportion of customers’ deposits in approved liquid assets. An
increase in the reserve ratios should reduce commercial banks’
lending and, therefore, the demand for hard currency, while a
decrease should yield the opposite effect.

 The secondary reserve requirement is a certain percentage of

commercial banks’ deposit liabilities that is to be held in approved
liquid assets. It should be freely and readily convertible into cash
without significant loss, free from any charge, lien or
encumbrance.

 The cash reserve requirement, also called primary reserve

requirements, is a percentage of commercial banks’ average
deposit liabilities that must be held at the Bank in a non-interest
bearing account. Cash reserves are a component of the secondary
reserve requirements.

 To encourage the development of the government securities

market, a securities requirement was instituted on 1 May 2010,
requiring commercial banks to hold a proportion of their average
deposit liabilities in the form of Treasury bills. The securities

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 MONETARY POLICY

requirement is also a component of the secondary reserve

requirements.

 Open market operations – The conduct of open market

operations refers to the purchase or sale of government securities
by the Bank to the banking and non-banking public for liquidity
management purposes. When the Bank sells securities, it reduces
commercial banks’ reserves (monetary base), and when it buys
securities, it increases banks’ reserves.

 Discount Window Lending - Discount window lending is where

the commercial banks, and other depository institutions, are able
to borrow reserves from the Central Bank at a discount rate. This
rate is usually set below short term market rates (T-bills). This
enables the institutions to vary credit conditions (i.e., the amount
of money they have to loan out), thereby affecting the money
supply. It is of note that the Discount Window is the only
instrument which the Central Banks do not have total control over.

By affecting the money supply, it is theorized, that monetary

policy can establish ranges for inflation, unemployment, interest
rates, and economic growth. A stable financial environment is
created in which savings and investment can occur, allowing for the
growth of the economy as a whole.

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 MONETARY POLICY

KEY RATES OF MONETARY POLICY

CASH RESERVE RATIO (CRR)

It is a percentage of cash every bank has to maintain with RBI.

The percentage is fixed by RBI. It is calculated based on the net
demand and time liabilities of a bank.

Demand liability is a type of liability in which the amount must

be paid on demand. For example, Current Account is a demand
liability i.e., the bank must pay the amount (a customer wishes to
withdraw) whenever he demands the amount he has in his Current
Account.

Time Liability is a type of liability in which the amount becomes

payable only on a certain point of time in future. For example, Fixed
Deposit is a time liability i.e., the bank must pay the amount (a
customer has in his fixed deposit) only on the date it gets matured.

STATUTORY LIQUIDITY RATIO (SLR)

It is a percentage of cash / gold / approved securities that a

bank must maintain with itself before lending to the customers. It is
calculated based on the total demand and time liabilities of a bank.
There is a difference between ‘net demand and time liabilities’ and
‘total demand time liabilities’. The methods of calculating both are
different which are prescribed by RBI.

The difference between CRR and SLR is that in CRR, banks has
to maintain Cash balance with RBI whereas in SLR, banks can
maintain themselves the prescribed percentage (by RBI) of reserve
not only in Cash but also in gold or approved securities. Both CRR

34
 MONETARY POLICY

and SLR are tools of monetary policy. But the SLR makes banks to
invest some portion of money in Government Securities (‘gilt edged
securities’) which are totally risk-free. The purpose of both CRR and
SLR are to curb the lending ability of banks and suck out excess
money from the economy.

REPO RATE AND REVERSE REPO RATE

REPO stands for ‘Re-Purchase Option’. In our country, both the

‘REPO Rate’ and the ‘Reverse REPO Rate’ are viewed only from the
angle of RBI which fixes both the rates. Hence, when banks give the
securities they hold to RBI and borrow money, the interest rate paid
by the banks to RBI is ‘REPO Rate’. When the RBI gives the
securities it holds to the banks and borrows money, the interest
rate paid by RBI is ‘Reverse REPO Rate’. RBI employs both these
rates to suck out excess money in short-term. Also for RBI, there is
no need to money borrow money from banks. But it does so to
absorb the excess money circulating in the economy.

When ‘REPO Rate’ is high, banks will not borrow much from
RBI and vice-versa. When ‘Reverse REPO Rate’ is high, banks will
find RBI an attractive destination to place their excess money (as
RBI will pay more interest to banks).

Thus, we can conclude that Repo Rate signifies the rate at

which liquidity is injected in the banking system by RBI, whereas
Reverse repo rate signifies the rate at which the central bank
absorbs liquidity from the banks

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 MONETARY POLICY

PRIME LENDING RATE (PLR)

‘Prime Lending Rate’ or ‘Prime Rate’ is an interest rate banks

lend money to their most favored and credit-worthy customers.

BASE RATE

It is the minimum rate of interest that an individual bank is

allowed to charge from its customers. Unless mandated by the
government, RBI rule stipulates that no bank can offer loans at a
rate lower than Base Rate to any of its customers. Your home loan
will always be equal to or more than the Base Rate but never lower
than Base Rate. So, the method of computation of interest rate for
various sectors becomes transparent

BANK RATE
This is the rate (long term) at which central bank (RBI) lends
money to other banks or financial institutions. If the bank rate goes
up, long-term interest rates also tend to move up, and vice-versa.
When bank rate is hiked, banks hike their own lending rates.

MARGINAL STANDING FACILITY (MSF)

Marginal Standing Facility (MSF) is the rate at which scheduled

banks could borrow funds overnight from the Reserve Bank of India
(RBI) against approved government securities. The basic difference
between Repo and MSF scheme is that in MSF banks can use the
securities under SLR to get loans from RBI and hence MSF rate is
1% more than repo rate.

36
 MONETARY POLICY

Sr. Rates / % W.e.f

No Reserve Ratios
1 Bank Rate 9.50 % 20th
sept.2013
2 Repo Rate 7.5 % 20th
sept.2013
3 Reverse Repo 6.50% 20th
Rate sept.2013
4 Cash Reserve 4.00% 20th
Ratio (CRR) sept.2013
5 Statutory 23% 20th
Liquidity Ratio sept.2013
(SLR)
6 MSF Rate 9.50% 20th
sept.2013
7 Base rate 9.70/10.25 20th
% sept.2013

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 MONETARY POLICY

1) Deepak Mohanty (2010) discusses the global financial crisis

and monetary policy response in India. At present, the focus around
the world and also in India has shifted from managing the crisis to
managing the recovery. The key challenge relates to the exit
strategy that needs to be designed, considering that the recovery is
as yet fragile but there is an uptake in inflation, though largely from
the supply side, which could engender inflationary expectations.
Now, the RBI‘s measures should help anchor inflationary
expectations, he opines, by reducing the overhang of liquidity
without jeopardizing the growth process as market liquidity remains
comfortable.

2) Robert Nobay and David Peel (2003) consider optimal

monetary policy in the context of the central bank adopting an
asymmetric objective function. The results show that under
asymmetric preferences, many of the extent results on the time
consistency problem need no longer hold. In this paper, they have
investigated the implications for optimal discretionary policy of
assuming that the central bank has an asymmetric loss function.
The results presented in this paper underline the fact that even
limited realism beyond the conventional approach to modeling the
authorities’ preferences can deliver results that are substantively at
variance with the results obtained under quadratic preferences.
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 MONETARY POLICY

3) According to Shankar Acharya (2002), conceptualization

and practice of monetary policy has clearly undergone a sea change
during the nineties. According to him, monetary policy at the end of
the decade was a far more sophisticated operation than at its
beginning. However, some of the old problems and dilemmas
remain. In particular, the efficacy of monetary policy continued to
be constrained by an excessively loose fiscal policy as well as an
insufficiently responsive financial system.

4) According to Errol D‘Souza, 2003. The RBI has been using

open market operations to sterilize the inflows of foreign capital so
as to contain domestic monetary expansion. At the same time, it is
intervening in foreign exchange markets. With downward price
rigidity and shocks such as declining foreign interest rates and
declining import tariffs as the economy integrates into the world
economy, it is imperative to revise the money supply target so as to
enable the economy to adjust to these shocks better. The current
policy of sterilization and containment of the money supply restricts
the process of income generation and macroeconomic adjustment in
the force of these shocks.

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 MONETARY POLICY

REFORMS IN THE INDIAN MONETARY POLICY

DURING 1990s

The Monetary Policy of the RBI has undergone massive changes

during the economic reform period. After 1991 the Monetary Policy
is disassociated from the Fiscal Policy. Under the reform period an
emphasis was given to the stable macro-economic situation and low
inflation policy. The major changes in the Indian Monetary Policy
during the decade of 1990 are given below:

 Reduced Reserve Requirements: During 1990s both the

Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR)
were reduced to considerable extent. The CRR was at its highest
15% plus and additional CRR of 10% was levied, however it was
now reduced by 4%. The SLR is reduced from 38.5% to a
minimum of 25%.

 Increased Micro Finance: In order to strengthen the rural

finance the RBI has focused more on the Self Help Group (SHG). It
comprises small and marginal farmers, agriculture and non-
agriculture labour, artisans and rural sections of the society.

40
 MONETARY POLICY

 Changed Interest Rate Structure: During the 1990s, the

interest rate structure was changed from its earlier administrated
rates to the market oriented or liberal rate of interest. Interest
rate slabs are now reduced up to 2 and minimum lending rates are
abolished. Similarly, lending rates above Rs. 2 lakhs are freed.

 Changes in Accordance to the External Reforms:

During the 1990, the external sector has undergone major
changes. It comprises lifting various controls on imports, reduced
tariffs, etc. The Monetary policy has shown the impact of liberal
inflow of the foreign capital and its implication on the domestic
money supply.

 Higher Market Orientation for Banking: The banking

sector got more autonomy and operational flexibility. More
freedom to banks for methods for assessing working funds and
other functioning has empowered and assured market orientation.

 Expectation as A Channel of Monetary

Transmission: Traditionally, there were four key channels of
monetary policy transmission:-Interest rate, credit availability,
asset prices and exchange rate channels. Interest rate is the most
dominant transmission channel as any change in monetary policy
has immediate effect on it. In recent year’s fifth channel,
Expectation has been added. Future expectations about asset
prices, general price and Income levels influence the four
traditional channels.

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 MONETARY POLICY

LIMITATIONS OF MONETARY POLICY

 Huge Budgetary Deficits: RBI makes every possible

attempt to control inflation and to balance money supply in the
market. However Central Government's huge budgetary deficits
have made monetary policy ineffective. Huge budgetary deficits
have resulted in excessive monetary growth.

 Coverage of Only Commercial Banks: Instruments of

monetary policy cover only commercial banks so inflationary
pressures caused by banking finance can be controlled by RBI, but
in India, inflation also results from deficit financing and scarcity of
goods on which RBI may not have any control.

 Problem of Management of Banks and Financial

Institutions: The monetary policy can succeed to control

inflation and to bring overall development only when the
management of banks and financial institutions are efficient and
dedicated. Many officials of banks and financial institutions are
corrupt and inefficient which leads to financial scams in this way
overall economy is affected.

 Unorganized Money Market: Presence of unorganized

sector of money market is one of the main obstacles in effective
working of the monetary policy. As RBI has no power over the
unorganized sector of money market, its monetary policy becomes
less effective.

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 MONETARY POLICY

 Less Accountability: At present time, the goals of monetary

policy in India are not set out in specific terms and there is
insufficient freedom in the use of instruments. In such a setting,
accountability tends to be weak as there is lack of clarity in the
responsibility of governments and RBI.
 Black Money: There is a growing presence of black money in
the economy. Black money falls beyond the purview of banking
control of RBI. It means large proposition of total money Supply in
a country remains outside the purview of RBI's monetary
management.

 Increase Volatility: The integration of domestic and foreign

exchange markets could lead to increased volatility in the
domestic market as the impact of exogenous factors could be
transmitted to domestic market. The widening of foreign exchange
market and development of rupee - foreign exchange swap would
reduce risks and volatility.

 Lack of Transparency: According to S. S. Tarapore, the

monetary policy formulation, in its present form in India, cannot
be continued indefinitely. For a more effective policy, it would be
necessary to have greater transparency in the policy formulation
and transmission process and the RBI would need to be clearly
demarcated.

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 MONETARY POLICY

CHAPTER - 5 CONCLUSION &

RECOMMENDATIONS

The research concludes that we have come to know many new

and important things about Monetary Policy which are made by RBI.
It is the central bank of India, plays an important role for proper
maintenance of Financial System in India.

In India the objectives of monetary policy evolved as

maintaining price stability and ensuring adequate flow of credit to
the productive sectors of the economy, with the progressive
liberalization and increasing globalization of the economy,
maintaining orderly conditions in the financial markets emerged as
additional policy objective. Thus, monetary policy in India
endeavors to maintain a judicious balance between price stability,
economic growth and financial stability.

If inefficient institutional environment increases the cost of

bank lending, banks may conduct lending activity in a manner that
weakens the effects of monetary policy actions on the supply of
loans by using reserves as a buffer to sustain their lending to low-
cost customers and to avoid lending to high-cost customers when
the central bank loosens credit conditions

Monetary policy is very essential for the economic

development of the country. If correct monetary measures are
taken at the right time it will help the country to survive even in the
difficult situation.

If monetary measures are not taken properly it may destroy

the economic position of the country.

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 MONETARY POLICY

In short we can say that monetary policy is a tool if it is used

properly it will help the country to grow smoothly. If not it is more
dangerous than an Atom Bomb.

The Reserve Bank recommends that the relative importance

of its objectives in a given context in a transparent manner,
emphasizes a consultative approach in policy formulation as well as
autonomy in policy operations and harmony with other elements of
macroeconomic policies. Improving transparency in our decisions
and actions is a constant endeavor at the Reserve Bank.

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 MONETARY POLICY

BY INDIA TODAY GROUP dated 13th September, 2013

 RBI to keep monetary policy tight till rupee

stabilizes: PMEAC
The Reserve Bank must continue its tight monetary policy until
stability in the rupee value is achieved, Prime Minister's key
economic advisor C Rangarajan said.

The current stance of monetary policy has to continue until

stability in the rupee is achieved. Thereafter, if the current trend in
the moderation of wholesale price inflation continues, which is in
fact expected, the monetary authorities can switch to a policy of
easing.

The time frame for this is difficult to specify and much depends
on stability in the foreign exchange markets, he said. The rupee
depreciated to 63.50 against the dollar on Thursday from 54.99 on
December 31.

Raghuram Rajan, who took over as RBI Governor on September

4, said that apart from monetary stability, the Central Bank has the
mandate for inclusive growth and development as well as financial
stability.

The Chairman of the Prime Minister's Economic Advisory Council

(PMEAC) said "there is a big dilemma facing the RBI because
controlling inflation, maintaining price stability, is one of the major
objectives of the monetary authority.

He said that it has to be taken into account the impact on growth

and what is happening in the real sector, but the primary
responsibility of price stability rests with the Reserve Bank of India

And he added that " the dominant factor influencing the monetary
authority will be the stability in the foreign exchange markets and if

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 MONETARY POLICY

the stability in the foreign exchange markets continues, it will give

greater room for the monetary authorities to act.”

By MUMBAI (Reuters) –dated 12th September, 2013

 RBI sets up panel to examine monetary policy

framework

The Reserve Bank of India on Thursday announced the details of its

committee constituted to examine the current monetary
policy framework and recommend ways to revise and strengthen it
to make it more transparent and predictable.

RBI Governor Raghuram Rajan, who took over on September 4, had

announced the committee would be headed by Deputy Governor

The other members in the committee are:

P.J. Nayak, Chetan Ghate, Associate Professor, economics and

planning unit at Indian Statistical Institute; Peter J. Montiel,
professor of economics, Williams College, USA; Sajjid Z. Chinoy,
Chief Economist and Executive Director at JP Morgan; Rupa Nitsure,
Chief Economist at Bank of Baroda; Gangadhar Darbha, Executive
Director, Nomura Securities; Deepak Mohanty, Executive Director,
RBI.

The panel will review the objectives, structure, operating framework

and instruments of monetary policy, particularly the multiple
indicator approach and the liquidity management framework, the
RBI said.

It will also identify regulatory, fiscal and other impediments to

monetary policy transmission, and recommend measures to
improve transmission.

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 MONETARY POLICY

 Reforms at RBI: A route to effective monetary

policy

If RBI has to efficiently perform its investment banking function

for the government, it has to sell bonds at high prices.
The Public Debt Management Agency of India Bill seeks to take
away the debt management function from the Reserve Bank of
India (RBI) and assign it to an independent agency. This will
eliminate one of the many conflicting interests of the central bank
and is in keeping with the best practice scenario offered by the most
recent studies on optimizing the role of the central bank.
If RBI has to efficiently perform its investment banking function
for the government, it has to sell bonds at high prices. This
obviously means that it will have a bias towards keeping interest
rates low when performing the monetary policy function.
Some of the other issues causing conflict of interest are
examined in depth by researchers at the National Institute of Public
Finance and Policy. Liberal economics argues that when the
government runs a monopoly and simultaneously has regulatory
powers over that sector, it leads to a great loss of efficiency and
dynamism. This is the situation with RBI when it comes to the
negotiated dealing system, subsidiary general ledger and the
payments system. RBI is a monopolistic entity and the regulator in
each of these areas.
The Securities and Exchange Board of India (SEBI) has shown
the way forward on the issue of conflicting interests in market
regulation. SEBI is pure regulator and does not trade on the market
nor does it run an exchange or a depository. Hence, shifting the
regulatory functions of the bond market and the currency market to
SEBI will create a regulatory architecture that is as good as that of
the equity market. There are other conflicts of interest owing to RBI
exercising banking regulation as well as supervision. Bonds could be

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 MONETARY POLICY

sold more effectively for the government by distorting rules for

banks. Alternatively, if banks are poorly regulated and are carrying
maturity mismatches and thus interest rate risk, the monetary
policy function of RBI might be loath to raise rates since this would
make life difficult for these banks.
Sometimes, the costs of implementing monetary policy are
borne by banks sometimes, banks benefit from the use of levers of
monetary policy (e.g., keeping interest rates low so as to ensure
that banks with interest rate exposure do not go bankrupt). Banking
regulation and supervision, hence, should be separated into a
banking regulatory and development authority which should also
takeover regulation and supervision of all deposit-taking
institutions. This will help RBI focus on monetary policy.
Monetary policy itself needs to be freed from the election cycle.
There is now ample evidence that independent central banks deliver
better monetary policy which is much more stable in nature and
helps in lowering inflation. However, independence also requires
fresh effort to infuse greater transparency. The report recommends
more regular policy meetings on a pre-announced schedule since it
would be helpful in giving markets a direction at predictable
intervals. For more effective communication, RBI could provide
more information to the public about its forecasting and simulation
models, which could in fact be useful for the central bank in getting
feedback from the academic and market communities that could
help improve the models.
These steps will not only enhance credibility of RBI but also of
the government.

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 MONETARY POLICY

QUESTIONNAIRE

1. What is the impact of monetary policy in functioning of

banks?

2. Why the certain reserves are have to be necessarily

maintained by banks?

3. What all the penalties borne by you for not following

RBI Rules?

4. What are the challenges banks face at the time of

change in monetary policy by RBI?

5. Does banks profitability affects due to changes in

monetary policy every 45 days?

6. What extent the banks are given autonomy in

monetary policies?

7. On what basis banks make changes in the interest

rates?

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 MONETARY POLICY

BIBLIOGRAPHY

 Laws Governing Banking and

Insurance (Sheth Publications,
Dr.Sumathi Gopal)

 Environment and Management

of Financial Services
(P.K. Bandgar, Vipul Prakashan)

 Newspapers(The Hindu, Financial

Express)

WEBLOGRAPHY

 http://in.finance.yahoo.com/new
s/rbis-priorities-may-see-
significant-183900462.html

 http://in.finance.yahoo.com/new
s/rbis-priorities-may-see-
significant-183900462.html

 http://profit.ndtv.com/news/economy/article-there-is-no-case-for-
indias-rating-downgrade-rangarajan-327126

 http://en.wikipedia.org/wiki/Monetary_policy_of_India

 http://study-material4u.blogspot.in/2012/07/chapter-3monetary-
policy-of-reserve.html

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