Banking Awareness: Monetary Policy of RBI

By Stuti Mishra|Updated : January 5th, 2021

Monetary policy is a macro-economic approach used by central bank (RBI) to manage the money supply for a healthy economic growth. We have come up with Monetary Policy of RBI here.

In an economy, Fiscal as well as Monetary policy is used to control money supply in the system. Fiscal policy is regulated by the Government of India and Monetary policy is regulated by RBI. Monetary policy is a macro-economic approach used by central bank (RBI) to manage the money supply for a healthy economic growth. 

Objectives of Monetary Policy

  • Primary Objective: To manage money supply and interest rates.
  • It basically help in balancing inflation, liquidity, consumptions, saving investments, etc
  • It also plays vital role in price stability, economic growth, job creation and social justice.

MPC (Monetary Policy Committee)

  • Monetary Policy Committee of India is a committee of the Reserve Bank of India that is responsible for fixing the benchmark interest rate in India.
  • Section 45ZB of the amended RBI Act, 1934 provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government to determine the interest rate that is required to achieve the inflation target.
  • The MPC is required to meet at least four times a year.
  • MPC is a 6-member body and is headed by RBI governor. There are 3 members from RBI and 3 members nominated by 
    • Current RBI Governor: Shaktikanta Das.
    • Other RBI Members: Deputy Governor (in-charge of monetary policy-Michael Patra) and executive director Janak Raj.
    • Current Government Nominated members: Ashima Goyal, Jayanth R Varma and Shashanka Bhide 

Instrument of Monetary Policy

There are several direct and indirect instruments that are used in the implementation of monetary policy.  RBI use following two measures to regulate the monetary policy: Quantitative and Qualitative Tools


Quantitative Tools

Variable Reserve Ratio (SLR, CRR)

  • Cash Reserve Ratio (CRR): Cash Reserve Ratio is the amount of funds that the banks are bound to keep with Reserve bank of India as a certain percentage of their Net Demand and Time Liabilities (NDTL). Bank cannot lend this amount. 
    • Present CRR: 3%
    • Bank earns no interest rate or profit on this ratio
    • All Scheduled Commercial Bank must keep CRR as per set by MPC but RBI may prescribe separate norms/ slabs for RRBs and Cooperative Banks.
    • When CRR is reduced, this means banks required to keep fewer funds with RBI and resource available to banks for lending will go up.
  • SLR (Statutory Liquidity Ratio): All commercial banks in the country required to keep a given percentage of their demand and time deposits (Net demand and time liabilities or NDTL) as liquid assets in their vault itself.
    • It prevents the bank from lending all its deposits which is too risky.
  • Note: Net Demand and Time Liabilities (NDTL) mainly consist of Time liabilities and Demand liabilities.
    • Time liabilities include:
      (1) Money deposited in Fixed deposits (FD)
      (2) Cash certificates
      (3) gold deposits etc.
    • Demand liabilities include:        
      (1) Money deposited in a savings account
      (2) Money deposited in current account
      (3) Demand drafts etc.

Open Market Operations (OMO)

  • OMO is a method in which RBI buys and sells Union and State Govt securities, bills, and bonds in the open market to expand or contract the amount of money in the system.
  • When RBI purchases Government securities, liquidity increases in the system (as RBI pays that party some money to buy that security or RBI is pouring additional money into the system).
  • On the reverse, when RBI sells Government securities, liquidity decreases in the system (as RBI is receiving cash in place of securities.)

Market Stabilizing Scheme (MSS)

  • In MSS, RBI sells Govt securities, Treasury bills and Cash Management Bills to absorb excess liquidity in the market. 
  • Money 

Liquidity Adjustment Facility (LAF)

  • Liquidity adjustment facilities (LAF) is a tool used by RBI to control short-term money supply.
  • It has two instruments:
    • Repo Rate: The interest rate at which the Reserve Bank provides loans to commercial banks by mortgaging their dated government securities and treasury bills. It is also known as 'Ready Forward Transaction'. Current Repo Rate: 4%.
    • Reverse Repo Rate: The interest rate at which the Reserve Bank borrows from commercial banks by mortgaging its dated government securities and treasury bills. Current Reverse Repo Rate: 3.35%.
  • While repo rate injects liquidity into the system, the Reverse repo absorbs the liquidity from the system.

Marginal Standing Facility (MSF)

  • MSF is a rate at which RBI lends short term loan to commercial banks for meeting their emergency requirements. It is generally given for a duration of a night to 14 days.
  • How is MSF different from Repo rate?
    MSF loan facility was created for commercial banks to borrow from RBI in emergency conditions when inter-bank liquidity dries up and there is a volatility in the overnight interest rates. To curb this volatility, RBI allowed them to deposit government securities and get more liquidity from RBI at a rate higher than the Repo rate.

Bank Rate

  • The bank rate is the rate which is fixed by RBI at which it re-discounts bills of exchange and government securities held by commercial banks.
  • It is also known as the discount rate.
    Note: Bill of exchange is a financial document that assures payment of money by the purchaser to the seller for goods purchased.
  • Differences between Repo rate and Bank rate: Repo Rate is a short-term measure, while Bank Rate is a long-term measure.

Long Term Repo Operation (LTRO)

  • LTRO is tool under which RBI provides 1 to 3 years money to banks at the prevailing repo rate.
  • These LTROs are given through RBI's e-Kuber platform
  • Interest rates on such tools are same as the repo rate.

Qualitative Tools

1. Credit rationing

  • In this, RBI controlled the maximum amount of credit flow to a certain sector.
  • RBI may also make compulsory for the banks to provide certain fractions of their loans to certain sectors such as priority sector lending etc.

2. Selective Credit control

  • Selective credit control is a tool in the hands of Reserve Bank of India to restrict bank finance against sensitive commodities.

3. Margin Requirements

  • RBI can prescribe margin against collateral. For instance, lend only 70 Rs. for 100 Rs. value Property, margin requirement being 30%. If RBI raises margin requirement, customers will be able to borrow less.

4. Moral suasion

  • Moral Suasion refers to a method of request, a method of advice by the RBI to the commercial banks to take certain measures as per the trend of the economy.

5. Direct Action

  • RBI issues certain guidelines from time to time based on the current situation in the economy. These guidelines should be followed by banks. If any bank violates these guidelines RBI penalizes them.


Current Policy Rates

Policy Repo Rate


Reverse Repo Rate


Marginal Standing Facility Rate


Bank Rate


Reserve Ratios






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