monetary policy project

8/12/2019 monetary policy project

1/51

MONETARY POLI CY

1

MEANING

A bank is a financial institution that provides banking and other

financial services to their customers. A bank is generally understoodas 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 offerscash 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, Indias 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

cashiers 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 roleaccepting deposits and

lending funds from these deposits.


2/51


3/51

MONETARY POLI CY

3

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.


4/51

MONETARY POLI CY

4

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


5/51

MONETARY POLI CY

5

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.


6/51

MONETARY POLI CY

6

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.


7/51


8/51

MONETARY POLI CY

8

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.


9/51

MONETARY POLI CY

9

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 toits advantage.

FUNCTIONS OF RBI Issue of Currency Notes Banker to The Government Bankers 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.


10/51

MONETARY POLI CY

10

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 ofinterest for the purpose of promotingeconomic 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 supplymore slowly than usual or even shrinks it. Expansionary policy is

traditionally used to try to combatunemployment in arecession by

loweringinterest rates in the hope that easy credit will entice

businesses into expanding. Contractionary policy is intended to

slowinflation 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.
http://en.wikipedia.org/wiki/Interesthttp://en.wikipedia.org/wiki/Economyhttp://en.wikipedia.org/wiki/Monetary_economicshttp://en.wikipedia.org/wiki/Expansionary_monetary_policyhttp://en.wikipedia.org/wiki/Unemploymenthttp://en.wikipedia.org/wiki/Recessionhttp://en.wikipedia.org/wiki/Interest_rateshttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Interest_rateshttp://en.wikipedia.org/wiki/Recessionhttp://en.wikipedia.org/wiki/Unemploymenthttp://en.wikipedia.org/wiki/Expansionary_monetary_policyhttp://en.wikipedia.org/wiki/Monetary_economicshttp://en.wikipedia.org/wiki/Economyhttp://en.wikipedia.org/wiki/Interest


11/51

MONETARY POLI CY

11

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 andfirms) believe

that policymakers are committed to loweringinflation, 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 nocost 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
http://en.wikipedia.org/wiki/Consumerhttp://en.wikipedia.org/wiki/Corporationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Cost_push_inflationhttp://en.wikipedia.org/wiki/Cost_push_inflationhttp://en.wikipedia.org/wiki/Inflationhttp://en.wikipedia.org/wiki/Corporationhttp://en.wikipedia.org/wiki/Consumer


12/51

MONETARY POLI CY

12

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 themarginal benefit of increasing economic output

outweighs themarginal cost of inflation); however, assuming

private agents haverational 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.
http://en.wikipedia.org/wiki/Demand_pull_inflationhttp://en.wikipedia.org/wiki/Cost_push_inflationhttp://en.wikipedia.org/wiki/Marginal_benefithttp://en.wikipedia.org/wiki/Marginal_costhttp://en.wikipedia.org/wiki/Rational_expectationshttp://en.wikipedia.org/wiki/Rational_expectationshttp://en.wikipedia.org/wiki/Marginal_costhttp://en.wikipedia.org/wiki/Marginal_benefithttp://en.wikipedia.org/wiki/Cost_push_inflationhttp://en.wikipedia.org/wiki/Demand_pull_inflation


13/51

MONETARY POLI CY

13

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%.


14/51

MONETARY POLI CY

14

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 Banksmonetary policy is that of overall expansion of money supply. In

the words of S.L.N. Sinha, The Reserve Banks 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 characterizedby the changing behavior of busy and slack seasons. Theseseasons 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


15/51

MONETARY POLI CY

15

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 restraininflation 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 policyadopted 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 isbiased 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: TheReserve 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.


16/51

MONETARY POLI CY

16

OBJECTIVES OF MONETARY POLICY

The main objective of monetary policy in India is growth with

stability. Monetary Management regulates availability, cost and useof 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.


17/51

MONETARY POLI CY

17

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).


18/51

MONETARY POLI CY

18

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 bankingfacilities 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.


19/51

MONETARY POLI CY

19

6.NEUTRALITY OF MONEY:-

Economists such as Wicksted, Robertson have always consideredmoney 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.


20/51

MONETARY POLI CY

20

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).


21/51

MONETARY POLI CY

21

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


22/51

MONETARY POLI CY

22

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 orother 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.


23/51

MONETARY POLI CY

23

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 foreignmonetary 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


24/51

MONETARY POLI CY

24

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.


25/51

MONETARY POLI CY

25

INSTRUMENTS OF MONETARY POLICY

The instruments of monetary policy are devise which are usedby 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


26/51

MONETARY POLI CY

26

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 theother 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 moneythey 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.


27/51

MONETARY POLI CY

27

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 ofthese 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.


28/51

MONETARY POLI CY

28

(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.


29/51

MONETARY POLI CY

29

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 helpcommercial 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 rationedby 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.


30/51


31/51

MONETARY POLI CY

31

MONETARY POLICY TOOLS

DIRECT POLICY TOOLSThese 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 announcethe 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 controlsThe 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 banksThe 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.


32/51

MONETARY POLI CY

32

INDIRECT POLICY TOOLSUsed 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 requirementsThe Bank uses reserve requirements tolimit the amount of funds that commercial banks can use to make

loans to its customers. Commercial banks are required to hold aproportion 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 requirementis a certain percentage ofcommercial 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 reserverequirements, 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 securitiesmarket, a securities requirementwas 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


33/51

MONETARY POLI CY

33

requirement is also a component of the secondary reserve

requirements.

Open market operations The conduct of open marketoperations 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 wherethe 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.


34/51

MONETARY POLI CY

34

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 demandliability 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


35/51

MONETARY POLI CY

35

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 excessmoney 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


36/51

MONETARY POLI CY

36

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.


37/51

MONETARY POLI CY

37

Sr.No

Rates /Reserve Ratios

% W.e.f

1 Bank Rate 9.50 % 20th

sept.2013

2 Repo Rate 7.5 % 20thsept.2013

3 Reverse RepoRate

6.50% 20thsept.2013

4 Cash ReserveRatio (CRR)

4.00% 20thsept.2013

5 StatutoryLiquidity Ratio

(SLR)

23% 20thsept.2013

6 MSF Rate 9.50% 20thsept.2013

7 Base rate 9.70/10.25%

20thsept.2013


38/51

MONETARY POLI CY

38

1) Deepak Mohanty (2010)discusses the global financial crisisand 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 RBIs 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 optimalmonetary 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 atvariance with the results obtained under quadratic preferences.


39/51

MONETARY POLI CY

39

3) According to Shankar Acharya (2002), conceptualizationand 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 DSouza, 2003.The RBI has been usingopen 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.


40/51

MONETARY POLI CY

40

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 Policyduring the decade of 1990 are given below:

Reduced Reserve Requirements: During 1990s both theCash 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 ruralfinance 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.


41/51

MONETARY POLI CY

41

Changed Interest Rate Structure: During the 1990s, theinterest 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 bankingsector 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 MonetaryTransmission: 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 years fifth channel,

Expectation has been added. Future expectations about asset

prices, general price and Income levels influence the four

traditional channels.


42/51

MONETARY POLI CY

42

LIMITATIONS OF MONETARY POLICY

Huge Budgetary Deficits: RBI makes every possibleattempt 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 ofmonetary 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 FinancialInstitutions: 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 unorganizedsector 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.


43/51

MONETARY POLI CY

43

Less Accountability:At present time, the goals of monetarypolicy 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 inthe 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 foreignexchange 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, themonetary 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.


44/51

MONETARY POLI CY

44

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 economicdevelopment 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.


45/51

MONETARY POLI CY

45

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.


46/51

MONETARY POLI CY

46

BY INDIA TODAY GROUP dated 13thSeptember, 2013

RBI to keep monetary policy tight till rupeestabilizes: 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 majorobjectives 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


47/51

MONETARY POLI CY

47

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 policyframework

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.


48/51

MONETARY POLI CY

48

Reforms at RBI: A route to effective monetarypolicy

If RBI has to efficiently perform its investment banking functionfor 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 RBIexercising banking regulation as well as supervision. Bonds could be


49/51

MONETARY POLI CY

49

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 wouldmake 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.


50/51

MONETARY POLI CY

50

QUESTIONNAIRE

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

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 ofchange 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?


51/51

MONETARY POLI CY

BIBLIOGRAPHY

Laws Governing Banking andInsurance (Sheth Publications,Dr.Sumathi Gopal)

Environment and Managementof Financial Services(P.K. Bandgar, Vipul Prakashan)

Newspapers(The Hindu, FinancialExpress)

WEBLOGRAPHY

http://in.finance.yahoo.com/news/rbis-priorities-may-see-

significant-183900462.html

http://in.finance.yahoo.com/news/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_Indiahttp://study-material4u.blogspot.in/2012/07/chapter-3monetary-

policy-of-reserve.html
http://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://profit.ndtv.com/news/economy/article-there-is-no-case-for-indias-rating-downgrade-rangarajan-327126http://profit.ndtv.com/news/economy/article-there-is-no-case-for-indias-rating-downgrade-rangarajan-327126http://profit.ndtv.com/news/economy/article-there-is-no-case-for-indias-rating-downgrade-rangarajan-327126http://profit.ndtv.com/news/economy/article-there-is-no-case-for-indias-rating-downgrade-rangarajan-327126http://profit.ndtv.com/news/economy/article-there-is-no-case-for-indias-rating-downgrade-rangarajan-327126http://en.wikipedia.org/wiki/Monetary_policy_of_Indiahttp://en.wikipedia.org/wiki/Monetary_policy_of_Indiahttp://en.wikipedia.org/wiki/Monetary_policy_of_Indiahttp://study-material4u.blogspot.in/2012/07/chapter-3monetary-policy-of-reserve.htmlhttp://study-material4u.blogspot.in/2012/07/chapter-3monetary-policy-of-reserve.htmlhttp://study-material4u.blogspot.in/2012/07/chapter-3monetary-policy-of-reserve.htmlhttp://study-material4u.blogspot.in/2012/07/chapter-3monetary-policy-of-reserve.htmlhttp://study-material4u.blogspot.in/2012/07/chapter-3monetary-policy-of-reserve.htmlhttp://study-material4u.blogspot.in/2012/07/chapter-3monetary-policy-of-reserve.htmlhttp://study-material4u.blogspot.in/2012/07/chapter-3monetary-policy-of-reserve.htmlhttp://en.wikipedia.org/wiki/Monetary_policy_of_Indiahttp://profit.ndtv.com/news/economy/article-there-is-no-case-for-indias-rating-downgrade-rangarajan-327126http://profit.ndtv.com/news/economy/article-there-is-no-case-for-indias-rating-downgrade-rangarajan-327126http://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.htmlhttp://in.finance.yahoo.com/news/rbis-priorities-may-see-significant-183900462.html

monetary policy project

Documents