What are RBI’s different tools through which it controls the money supply and impact of those tools on the factors which they are targeted on. Open Market Operations (OMOs) involve sale and purchase of Government securities (G-Secs) by the RBI to adjust the liquidity conditions in the system. RBI conducts such selling operations to suck liquidity whenever it feels there is excess liquidity in the system. Similarly, when the liquidity conditions are tight, RBI goes for such buying operations in the open market, thereby releasing liquidity into the system. Liquidity Adjustment Facility (LAF) is a policy tool which allows banks to borrow money from the RBI through repurchase agreements, popularly called repo transactions. As the name itself suggests, LAF has been provided to aid the banks in adjusting their day-to-day liquidity mismatches. LAF consists of repo and reverse repo operations. Repo transactions inject liquidity into the system, while reverse repo transactions result in absorption of excess liquidity. Repo Rate is the rate at which commercial banks borrow money from the RBI for a short period of time. Banks sell their securities or financial assets to the RBI with an agreement to repurchase them at a predetermined price at some future date. Expected Outcome: A high Repo Rate deters the banks to raise funds from the RBI, forces banks to keep their own lending and deposit rates high and thereby, keeps money supply in check. This is what RBI tried to do on July 16th, which caused panic among the market participants and banks/corporates scrambled to shore up their cash holdings. Higher interest rates normally curtail investments, as a result of which the overall consumption and aggregate demand start falling. Lower demand results in lower resource utilization. When resource utilization is low, prices and wages usually rise at a more modest rate. On the other hand, RBI purposefully reduces Repo Rate as and when it wants to encourage banks to borrow money for further lending to spur investments. Reverse Repo Rate is the rate at which banks deposit their excess money with the RBI for a short period of time. RBI lowers the Reverse Repo Rate whenever it wants banks not to deposit incremental cash with it, thereby raise liquidity in the banking system for further lending and to raise overall investment levels and hence the aggregate demand. It also makes banks to offer lower rate of interest on the deposits made by the general public. But, at the same time, it allows banks to lend at a lower rate. Reverse Repo Rate remains fixed these days at 100 basis points (or 1%) below the Repo Rate. Cash Reserve Ratio (CRR) is the percentage of a bank’s total deposits, which the bank is required to maintain with the RBI. Banks are mandated to deposit this amount with the RBI on a fortnightly basis. CRR is a tool used by the RBI to control the liquidity in the system. Expected Outcome: So, when there is excess money floating around in the system, RBI will raise the CRR to suck out the excess money. On the other hand, if there is a credit crunch, RBI cuts the CRR to release money into the system. Normally, CRR cut increases liquidity in the system to a marginal extent only. Statutory Liquidity ratio (SLR) is the proportion of deposits that banks are required to maintain in cash or gold or government approved securities. Expected Outcome: Similar to CRR, a reduction in SLR also increases some money supply in the financial system. After keeping the required amount for CRR & SLR, the banks are free to use the remaining deposits for their lending purposes.
Posted on: Mon, 09 Sep 2013 17:19:08 +0000
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