MONETARY POLICY

1. CRR, SLR,
2. Repo, Reverse
Repo,
3. PSL, MSF, LAF,
OMO
4. Qualitative tools
5. Urjit Patel
Committee

1. Evolution
2. Bank nationalization
3. Narsimhan
Committee
4. Bank vs NBFC
5. New Bank Licenses

BANKING SECTOR
Todays Topics
Powerpoint Slides available at Mrunal.org/Economy
Before money was invented
2 kg
500 gms
Double
Coincidence
Of wants
Birth & Evolution
Inflation
1 kg = Rs.100
Inflation
1 kg =
Rs.1000
Quantitative/
General/Indirect
1. Reserve Ratios
(CRR, SLR)
2. OMO: Open market
operations
3. Rates (Repo, RR,
Bank, MSF, LAF)




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

Reserve Ratios
Deposit Examples
Time Deposit FDRD
Demand
Deposit
CASA
NDTL +100 cr.
Reserve
ratio
CRR (-) 15 [no
profit]
All Banks
Penalty
No profit. Except 1999.
Right now 4%
Cash Reserve Ratio (CRR)
Deposit Examples
Time Deposit FDRD
Demand Deposit CASA
Net Demand and
Time Liabilities
(NDTL)
+100 cr.
Reserve
CRR (-) 15 [no profit]
SLR (-) 40 [some profit]
Money left with bank =45
All banks
Cash, gold, RBI
approved securities
Right now 22.5%
Helps during Bank
Runs
Statutory Liquidity Ratio
Cyclic fluctuation: Inflation
Loan: 10%
CRR, SLR: 0%

RBI raises SLR, CRR
Bank have less money
left.
Need to raise loan
interest rate to keep
profit margin same.
Cyclic fluctuation: Inflation
Loan: 20%
CRR, SLR: 50%
Hike in Bank Loan Interest Rates
10%
20%
50,000/-
48,000/-
Hike in Bank Loan Interest Rates
10%
20%
Inflation
RBI raises SLR, CRR RBI decreases SLR,
CRR
Banks are left with
more money
People can borrow
more.
Deflation
Cyclic fluctuations
Quant. Tool Inflation fight Deflation
fight
CRR,
SLR
OMO
Monetary Policy
Quant. Tool Inflation fight Deflation
fight
CRR,
SLR
Increase
OMO
Monetary Policy
Quant. Tool Inflation fight
(tight/dear)
Deflation
fight
CRR,
SLR
Increase
OMO
Monetary Policy
Quant. Tool Inflation fight
(tight/dear)
Deflation
fight
(easy/cheap)
CRR,
SLR
Increase Decrease
OMO
Monetary Policy
TERM meaning Desirable?
DEFLATION
fall in the prices
fall in
employment.
No.
DISINFLATION
Fall in the prices
but without
creating
unemployment.
yes
Terms
STAGFLATION
1.stagnation + inflation
2.prices and wages rise
3.cant find jobs
4.cant find customers.
REFLATION
policy to stop the fall in
price levels,
but without causing rise
in the price levels
(inflation).
When RBI increases CRR, what does it
mean?
A. RBI will have less money to lend
B. Union government will have less money to
spend.
C. Commercial banks will have more money
to lend
D. Commercial banks will have less money to
lend
Mock Question UPSC 2010
1. Skip 2. Attempt 3. Mark n
Review
When RBI announces an increase of Cash
reserve ratio, what does it mean?
A. RBI will have less money to lend (irrelevant)
B. Union government will have less money to
spend. (irrelevant)
C. Commercial banks will have more money to
lend (Deflation=> reduce CRR)
D. Commercial banks will have less money to
lend (right)
Mock Question UPSC 2010
1. Skip 2. Attempt 3. Mark n
Review
Monetary Policy
Quantitative tools
1.Reserve Ratio
2.Open Market operation
(OMO)
Government securities
Inflation: Open Market Ops.
Inflation: Open Market Ops.
Quant. Tool Inflation fight
(tight/dear)
Deflation
fight
(easy/cheap)
CRR,
SLR
OMO
Monetary Policy
Quant. Tool Inflation fight
(tight/dear)
Deflation
fight
(easy/cheap)
CRR,
SLR
Increase Decrease
OMO
Monetary Policy
Quant. Tool Inflation
fight
Deflation
fight
CRR,
SLR
Increase Decrease
OMO Sell Buy
Monetary Policy
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
MCQ (UPSC-2013)
1. Skip 2. Attempt 3. Mark n
Review
In context of Indian Economy, Open Market
Operation refers to
1. Borrowing by scheduled banks from RBI
(Repo/Bank)
2. Lending by commercial banks to industries and
trade (irrelevant)
3. Purchase and sale of government securities by
the RBI (RIGHT)
4. None of Above
MCQ (UPSC-2013)
1. Skip 2. Attempt 3. Mark n
Review
1. Central bank purchase
of G-sec from public
2. Public deposits
currency in
commercial
3. Government borrows
from the central bank.
4. Central Bank sells G-
sec to public


Answer choice
A. Only 1
B. 2 and 4
C. 1 and 3
D. 2, 3 and 4

Which of the following measures increase in the money supply in economy?
(CSAT-2012)
1. Skip 2. Attempt 3. Mark n
Review
Which of the following measures would result in an
increase in the money supply in economy? (CSAT-2012)
1. Purchase of government securities from public by
central bank (increases)
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? (CSAT-2012)
1. Purchase of government securities from public by
central bank (increases)
2. Deposit of currency in commercial banks by the public
3. Borrowing by government from the central bank.
(public finance)
4. Sale of government securities to the public by central
bank. (money supply decrease)
Answer choice
A. Only 1
B. 2 and 4
C. 1 and 3
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? (CSAT-2012)
1. Purchase of government securities from public by
central bank (increases)
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
Monetary Policy
Quantitative tools
1.Reserve Ratio (CRR, SLR)
2.Open Market operation (OMO)
3.Rates: Bank Rate, Repo Rate, MSF,
LAF
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.
Bank Rate: WHAT?
Linked with penal rates:
If CRR, SLR not maintained.
Penalty= (Bank rate + 3%); 5%
Worst case: license cancelled.
Bank Rate: WHY?
Increase in the Bank rate indicates that
A. Market rate of interest rate is likely to fall
B. Central Bank is no longer making loans to
commercial banks.
C. Central bank is following an easy money
policy
D. Central bank is following an tight money
policy

MCQ (UPSC-2013)
1. Skip 2. Attempt 3. Mark n
Review
Increase in the Bank rate generally indicates that
A. Market rate of interest rate is likely to fall
(REVERSE)
B. Central Bank is no longer making loans to
commercial banks. (WRONG)
C. Central bank is following an easy money policy
(REVERSE)
D. Central bank is following an tight money policy
(right)

MCQ (UPSC-2013)
1. Skip 2. Attempt 3. Mark n
Review
Collateral? = Government security.
LAF: Liquidity Adjustment Facility (2000)
LAF Short term loans.
Repo When banks borrow
from RBI. 8%
Reverse
Repo
When banks deposit
money in RBI. 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. All Banks
3. NBFI (LIC, UTI)
1 cr.
Only scheduled
commercial banks can
bid.

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


R+1%
MSF
Whats the difference?
Reverse repo rate = it is interest rate paid
by RBI to its clients for short term loans.
Central & State Government, All Banks,
NBFI
Collateral: government securities
2011: RR = Repo 1% (100 basis points).
1
st
April 2014: Repo = 8%.
Reverse repo =8-1=7%
Reverse Repo
Repo (8%)
POLICY RATE
Quant. Tool Inflation
fight
Deflation
fight
CRR,
SLR
Increase Decrease
OMO Sell Buy
Policy
Rate
Increase Decrease
Monetary Policy
How does Repo affects economy?
How does Policy rate affects economy?
1.People dont have many investment
alternatives. Commercial banks
have high deposits.
2.Unorganized money market; Shroff;
lack of financial inclusion
3.Monsoon uncertainty, cyclone,
flood, draughts => Supply side
constrains
Monetary Policy: limitations (Developing-countries)
1.Crude oil, gold import
2.Fiscal deficit; public borrowing
3.subsidy leakage, Black money,
underground economy

Monetary Policy: limitations (Developing-countries)
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
Monetary Policy: 28
th
Jan 2014
Repo: 8
MSF: Repo + 1%: 9%
RR: Repo 1%=7%
CRR: 4%
SLR : 23 => 22.5%
40k additional liquidity
El Nino effect = less
monsoon
Liberalised Remittance
Scheme (LRS)
75k=> $1,25,000

Monetary Policy: 1 April 2014
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
Inflation declined but
not enough
Geo-political
development,
Commodity
El Nino effect = less
monsoon


Monetary Policy: 3
rd
June 2014
Quantitative/
General/Indirect
1. Reserve Ratios
(CRR, SLR)
2. OMO: Open market
op.
3. Policy rate

Qualitative/Selective/
Direct
Monetary Policy: Instruments?
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
Qualitative: Consumer Credit
Ceiling on total loans in
each sector.
Planned economy
PSL: 40% =>60%

Selective, Direct
Monetary Policy: Qualitative: Rationing
Target
Desi
(+Foreign
>20)
Foreign <20
Overall PSL
target
40% of net
loans given
32%
Priority Sector lending
Target
Desi (+Foreign
>20)
Foreign <20
Agro 18% No specific targets
Weaker sections 10% No specific targets
Remaining
categories under
PSL*
Whatever left to
reach the 40%
target
No specific targets
Overall PSL target
40% of net loans
given
32%
Priority Sector lending
*Housing loans, Edu, small
industries
Desi (+Foreign >20) Foreign bank <20
Remaining $$ to RIFT To SEDF
Rural infra. Development
fund
small enterprises Dvlp. Fund
NABARD manages SIDBI manages
NABARD pays interest rate
to the bank (RBI decides the
rate)
Same by SIDBI
State governments get infra.
Loan
Similar case: state industrial
fin.corp.
PSL: What if targets not met?
Priority sector lending by Banks in India
Constitutes the lending to
A. Agriculture
B. Micro and small enterprises
C. Weaker section
D. All of above.
Mock Question UPSC CSAT 2013
1. Skip 2. Attempt 3. Mark n
Review
Right answer
Quantitative/
General/Indirect
1. Reserve Ratios
(CRR, SLR)
2. OMO: Open market
op.
3. Policy rate
1. Margin LTV
2. Downpayment /
Consumer credit
control
3. Credit rationing


Qualitative/Selective/
Direct
Monetary Policy: Instruments?
Moral Suasion Direct Action
Monetary Policy: Qualitative
Quantitative/
General/Indirect
1. Reserve Ratios
2. OMO: Open
market op.
3. Policy Rate
1. Margin / LTV
(Akshay)
2. Consumer Credit /
Downpayment (Nano)
3. Rationing (Stalin)
4. Moral Suasion
5. Direct Action
Qualitative/Selective/
Direct
Monetary Policy: Instruments?
Which of the following is not an instrument of
selective credit control in India?
A. Regulation of consumer credit
B. Rationing of credit
C. Margin requirements
D. Cash reserve ratio
MCQ (UPSC-1995)
1. Skip 2. Attempt 3. Mark n
Review
Right answer
RBI Acts as bankers
bank. This would imply?
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.

MCQ (2012)
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 UPSC CSAT 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
Bimal Jalan
Retired governor
New Bank Licenses
Feb 2014 report given
Nachiket Mor
RBI board of directors.
Financial products for small businessmen and low income household.
Financial inclusion: banking, credit, investment, insurance. + consumer protection
Urjit Patel
Dy. Governor
Revise and Strengthen Monetary policy framework

Committees by RBI
Expert Committee to Revise and Strengthen
the Monetary Policy Framework
September 2013
Report in 3 months=> Jan 2014 report.
PJ Nayak, Chetan Ghate et al.
Recommendation:
1. RBI Target inflation
2. Government help RBI
3. RBI fix accountability

Urjit Patel Committee
Highest within G20 nations
Higher than its trade competitors => export competitiveness ..X
Why target inflation?
CPI 2008 2012
World 4 4
Brazil 5 5
China 6 <3
India 9 >10
S.Africa 11 6
Russia 14 5
4 4
5 5
6
2.7
9
10.4
11
6
14
5
2008 2012
CPI from 2008 to 2012
World Brazil China
India S.Africa Russia
Onion
Rs./kg
Mon
ey
Buy?
1st
Jan
20 100 5 kg
31st
Dec
100 104 ~1 kg
Why target inflation?: Nominal vs Real
interest
Money
saved in
Bank
Nomina
l
Interest
Rate
CPI
(Inflation)
Real Rate of
Interest=(Nom
inal-Inflation)
SA 4.00% 11% -7%
FD 9.00% 11% -2%
Why Indians buy gold?
Excessive gold import=>CAD=>Rupee
Weaken =>Petrol=>inflation (Vicious cycle)
Saving=>capital..X
Indicators used:
IIP, Consumer confidence
Professional forecasts
(CRISIL, S&P, Moody,
World Bank): GDP,
inflation, unemployment
Inflation: WPI minus food,
fuel.
Focus:
Employment, GDP,
inflation, exchange rate
stable,


1998-2008 worked well. But
not anymore. GDP, Inflation.
2008: CPI ** double digit
(>10)
WPI: service sector
>60%GDP.
WPI commodity list revised
often. (ice cream, oven,
cricket ball, guitar.)
Impact after Lag of 3-4
quarters.



Negative
Nominal Anchor: Multiple Indicator
Lower Limit? (2%)
Zero / negative
inflation =bad.
Deflation. Real
interest.
Moderate level
Minimum 2%.
Studies show CPI
>6.2% = bad for
growth, exchange rate,
employment,
investment.
Maximum: 6%.

Upper limit (6%)
Nominal Anchor CPI: What target?
Lower Limit? (2%)
Zero / negative
inflation =bad.
Deflation. Real
interest.
Moderate level
Minimum 2%.
Studies show CPI
>6.2% = bad for
growth, investment.
Maximum: 6%

Upper limit (6%)
Nominal Anchor CPI: What target?
Country Target Band
Mexico 3 1
South
Africa
3-6%
Israel 1-3%
Chile:
90s CPI 25%
2000s: CPI target 3% (+/- 1%
band)
Nominal Anchor 4% CPI: When? Timeframe
0 12 24 36
Target 10 8%6%4%
10%
8%
6%
4%
0%
5%
10%
15%
URJITS
TARGET FOR
INDIA
Policy rate= LAF repo Rate
Decided by voting in MPC.
Reverse repo=-1% (100 basis point)
MSF=+1%
Spread +1/-1 should not be changed frequently.
Nominal Anchor 4% CPI: How? RBI?
Repo
(8%)*
Expert Committee to Revise and
Strengthen the Monetary Policy
Framework
Recommendation:
1. RBI Target inflation:
1. Nominal Anchor CPI (combined)
2. 4% (2%)
3. 10/8/6=> 0/12/24
2. Government help RBI
3. RBI fix accountability

Urjit Patel Committee
MNREGA: wage increasedyes.
Productive growthno?
Food security: production increase? MSP,
subsidy leakage.
Administered pricex
Interest rate subvention..x
Fiscal consolidation
2016-17: fiscal deficit GDP 3% (present
~5%)
Nominal Anchor 4% CPI: How? Government?
RBI Act.
Governor directly accountable to Government
of India.
Govt. can issue directives to RBI in public
interest.
Parliaments standing Committee on finance-
can summon Rajan. Avg. 3-4/year.
Monetary policy made by Governor alone.
(sign.)
OVERALL No formal accountability
mechanism.
Monetary Policy: accountability in India
Two members- external (finance, economics
etc.). Can access records.
Office of profit . x
Conflict of interestx
Term: 3 years, Non-renewable.
Decision by Majority Voting. Casting vote:
Rajan / Dy.Gov.
Meet once every two months.
Minutes of meeting- publish.
Bi-annual report publish.
Urjit: Monetary Policy: accountability in India
(Suggestion)
Target: 4% (2% band)= 2-6% .
Failure?? Three quarters successively.
MPC issue public statement
1. Each member will sign it
2. Reasons for failure
3. Action proposed
4. Time-frame for result.



Urjit: Monetary Policy: accountability in India
(Suggestion)
Expert Committee to Revise and
Strengthen the Monetary Policy
Framework
Recommendation:
1. RBI Target inflation:
1. Nominal Anchor CPI (combined)
2. 4% (2%)
3. 10/8/6=> 0/12/24
2. Government help RBI=> fiscal deficit.
3. RBI fix accountability=> MPC.

Urjit Patel Committee
2011: Salient recommendations of the RBI-
appointed Damodaran committee on
customer service in Banks. (12m / 150
words.)
Formed in 2010
Gave report in 2011.
Mains answer writing
Write a note on the recommendations of Dr.
Urjit Patel Committee to strengthen
monetary policy framework in India. (10m |
200 words)

GS2, GS3
1. Despite frequent revisions in monetary
policy rates, RBI has failed to contain
inflation in recent times. Why?
2. (role playing) What will you do? If
youre made the governor of RBI.
3. (role playing) What will you do? If
youre made the Finance/Agri. Minister
of India?
Interview