Direct & Indirect Instruments

Reserve Bank of India

Presented by:

Mayank Satia

Hemlata Raundhal

Abin Mathew

Ankita Shirsat

MONETARY POLICYo Monetary policy refers to the use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit.

o Objectives of monetary policy in India are:

i) Maintaining price stability

ii)Ensuring adequate flow of credit to the productive sectors of the economy to support economic growth

iii)Financial stability

MONEY INSTRUMENTS

• CRR• SLR• Refinance Facilities

DirectInstrume

nts

• LAF• OMO• MSS• Repo/Reverse Repo Rate• Bank Rate

IndirectInstrume

nts

CASH RESERVE RATIO (CRR)

• It is a banking regulation that sets the minimum reserves each bank must hold by way of cash. It is expressed in terms of percentage.

• CRR is also called as Liquidity Ratio as it seeks to control the money supply in the economy.

In US it is called the Federal Reserve.

• These deposits are designed to satisfy cash withdrawal demands of customers and to maintain liquidity in the market.

MAINTENANCE OF CRR• In terms of Sec 42 (1) of the RBI Act, 1934,

Scheduled Commercial Banks are required to maintain with RBI an average cash balance, the amount of which shall not be less than 3% of the total of the NDTL in India, on fortnightly basis and RBI is empowered to increase the rate to such higher rate not exceeding 20% of the NDTL under the RBI Act, 1934.

STATUTORY LIQUIDITY RATIO

• SLR is the amount which the banks has to maintain in the form of cash, gold and approved securities.

• The rate is specified as some percentage of TDTL.

• The date at which is taken to calculate the demand and time liabilities of the bank is the last Friday of the preceding fortnight.

MAINTENANCE OF SLRScheduled Commercial Banks are required to maintain under Sec 42 of the RBI Act, 1934, are required to maintain in India:

• a) Cash

• b) In gold valued at a price not exceeding its current market price.

• c) In unencumbered approved securities valued at a price as specified by the RBI on time to time.

IMPACTS OF CRR AND SLR• Liquidity• The rates help control liquidity and accelerate credit growth in an

economy.

• CRR is 6%

Eg: If a bank has Rs 1,00,000 as deposits then the bank will be able to

lend

only Rs 94000/- as Rs 6000/- will be kept as reserves with the bank.

• Now in the above example if the CRR rate goes down to 5%, the bank

will be able to lend Rs 95000/-

INTEREST RATES1) IR depends upon the demand from the borrowers – supply from the banks.

2) Hike in CRR and SLR would reduce the lending ability of the banks and demand of the borrowers remaining the same the interest rates would shoot up.

3) Decrease in CRR and SLR would have a double impact –

i) Increase in liquidity in the market

ii) Interest rates on short term deposits will also go down.

EXCHANGE RATES• Cut in reserve requirements would raise the level of

liquidity which would decrease the inflow of foreign money for interest rate arbitrage and thus would stem the rupee rise higher.

• Hike in CRR decline in liquidity higher interest rates rupee depreciates.

• Cut in CRR Rise in liquidity fall in interest rates Rupee depreciates.

COMMON MAN• Hike in reserve requirements

a)Higher returns from the debt-oriented instruments

b)Loans would become costly as the banks would charge higher rate of interest.

i) Fixed interest rate

ii) Floating interest rate

REFINANCE FACILITIES• Refinancing may refer to the replacement of an existing debt

obligation with a debt obligation under different terms.

• The terms and conditions of refinancing may vary widely by country, province, or state, based on several economic factors such as, inherent risk, projected risk, political stability of a nation, currency stability, banking regulations, borrower's credit worthiness, and credit rating of a nation.

• There are various types of refinance offered by RBI.

• Reserve Bank of India permitted the banks to offer refinance on various loans. However, refinance companies have the restriction to use floating provisions instead of specific provisioning.

• Refinance by RBI is also offered to boost the growth of SMEs (Small and Medium Enterprises), especially those which are currently facing credit crunch.

• RBI also offers refinance facility to help out the exporters.

• In 2008, RBI offered credit lines of 5,000 crores to Export-Import Bank of India (Exim Bank) to support the export sector.

• Export Credit Refinance Facility

RBI offers export credit refinance facility to the scheduled banks under Section 17(3A) of RBI Act 1934.

• Credit refinance was offered up to 15% of the outstanding export credit. Repo Rate is applicable on the export credit refinance.

• The monthly payable interest is calculated on daily balances, which gets debited to the account.

• The maximum duration for repayment is 180 days.

• One can apply for an export credit refinance of Rupees one lakh and multiple of thereof.

SPECIAL REFINANCE FACILITY (SRF)

Special refinance facility was introduced under Section 17(3B) of RBI Act, 1934. It allows scheduled commercial banks (except Regional Rural Banks) to refinance up to 1% of Net Demand and Time Liabilities (NDTL) of each bank. Repo rate under LAF (Liquidity Adjustment Facility) is applicable for this facility. With effect from November 3, 2008, the rate lies at 7.5%.

• MUMBAI, JUNE 18: 

• The Reserve Bank of India has decided to enhance the export credit refinance limit to 50 per cent of the outstanding rupee export credit for banks from 15 per cent, a move that will inject Rs 30,000 crores into the system.

LIQUIDITY ADJUSTMENT FACILITY (LAF)

• It is a monetary policy tool which allows banks to borrow money through repurchase agreements.

• Liquidity adjustment facilities are used to aid banks in resolving any short-term cash shortages during periods of economic instability or from any other form of stress caused by forces beyond their control.

• Various banks will use eligible securities as collateral through a repo agreement and will use the funds to alleviate their short-term requirements, thus remaining stable.

• An activity by Central bank to buy or sell government bonds on the open market.

• Aim of OMO is to control the short term interest rate and the supply of base money in an economy.

• Indirectly control the total money supply available in the market.

• It helps regulate interest rates and foreign exchange rates.

OPEN MARKET OPERATIONS

Prior to 1991 financial reforms,

Major source of funding and control over credit and interest rates

CRR (Cash reserve ratio)SLR (Statutory Liquidity Ratio).

After 1991 financial reforms,

Use of CRR as an effective tool was de-emphasized and the use of open market operations increased.

OMO’s are more effective in adjusting market liquidity.

OUTCOME OF AN OMO• When the RBI buys bonds from the market and infuses

liquidity, the consequences are:

• It tends to soften the interest rates.

• Fresh bonds can be issued at lower yields and the government can thus borrow at a reasonable cost.

• It enables corporates to borrow at favorable interest

rates.

• It prevents the rupee from strengthening unnecessarily and thereby protects the interest of exporters.

• It may tend to increase inflation.

MARKET STABILIZATION SCHEME (MSS)

• Also know as Intervention bonds.

• Used by Central Banks to mop up liquidity caused by Foreign Exchange Market intervention.

• LAF and the OMO’s were dealing with day to day liquidity management.

• MSS was set up to sterilize the liquidity absorption and make it more enduring.

• Funds transferred to separate account (MSSA) instead of Governments account.

• REPO is an instrument of Money Market

• Reserve bank charges some interest rate on the cash borrowed by banks. This rate is usually less than the interest rate on bonds as the borrowing is collateral. This interest rate is called ‘repo rate’.

• Reserve bank and commercial banks involve in repo transactions but not restricted to these two.

• Borrower of funds is called as seller of repo and lender of funds is called as buyer of repo.

• Current REPO rate is 8%

REPO RATE

• A low repo rate signifies that banks are able to borrow funds cheap and subsequently, will lend to customers too at a relatively lower rate.

• The repo rate is also considered the benchmark rate for the economy. Lower rates are seen as an aid to economic growth as finance is accessible at less cost and that helps people borrow money cheap to invest in ventures.

• A cut in this rate is considered a signal to boost economic growth, which overall is a good move and gets reflected through positive reaction in equity markets.

IMPACT OF REPO RATE ON ECONOMY

• Reverse Repo rate is the rate at which the RBI borrows money from commercial banks.

• In a reverse repo Reserve Bank borrows money from banks by lending securities. The interest paid by Reserve Bank in this case is called reverse repo rate.

• An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this attractive interest rates.

• This tool can be used by RBI to drain excess money out of the banking System.

• Current Reverse REPO Rate : 7%

REVERSE REPO

• Bank rate, also referred to as the discount rate, is the rate of interest which a central bank charges on the loans and advances to a commercial bank.

• This is typically done on a quarterly basis to control inflation and stabilize the country’s exchange rates

• It is the rate which central bank provides to the commercial bank for the excess reserves being kept with the central bank

• The bank rate acts as the penal rate charged on banks for shortfalls in meeting their reserve requirements

• Current Bank Rate : 9%

BANK RATE

DIFFERENCE BETWEEN BANK RATE & REPO RATE

• Whenever the banks have any shortage of funds they can borrow it from the central bank. - Bank Rate

• Repo (Repurchase) rate is the rate at which the central bank lends short-term money to the banks against securities.

Thank You