monetory policy in india

8/12/2019 Monetory Policy in india

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MONITORY POLICY OFRBI



Money Definition & Function

Money is Often confused between Income or WealthEarning of a person is his/her income. Money is used tomake payment of income.Money is not a saving or wealth but just a medium in whichthese are retained.Money is commonly defined by the functions attached to itthat it is

a commodityor a token

that can act as;® Medium of exchange® Unit of account® Store of value® And Standard of deferred payment



Money Function

Functions ofMoney

PrimaryFunctions

Secondary

Functions

Medium of ExchangeUnit of Account

Store of Value

Standard ofDeferred payment



Demand for Money

Motives of holding Money

Transaction

Precautionary Speculative

Positivelyrelated to realincome & PriceLevel

With theincrease inIndividualsincome or pricesof goods/services shoots

Positivelyrelated to realincome & PriceLevelMoney is heldfor coveringunexpectedexpenditure andcontingencies

Asset Demandfor Money

Store of value



Supply of Money

Money supply classification ofsectors

Money creating

sector

Money using

sector

Government

CentralBank

Household

Non financialEnterprises

Financial

Enterprisesother thanbanks

Rest of theworld



Measurement of Money

M1: Currency Notes +Coins +DemandDepositsM2 : M1+ Post officeSaving DepositsM3 : M1+ Time Depositsof all commercial &cooperative BanksM4 : M3 + Total Depositwith the post officesaving organization

NM1 Demand deposits withthe banking system + ‘Other’ deposits with the RBI.(Narrow Money)NM2 : NM 1+ Short-term timedeposits of resident + CD’s (Intermediate Monetary

Aggregate)

NM3: NM2 of residents +LongTerm deposits of resident+Call/Term funding fromfinancial institutions. (BroadMoney)

OLD NEW



Liquidity Indicator

L1 = NM3+ All deposits with the post officesaving banks ( excluding National savingcertificate).

L2 = L1+ Term deposits with term lendinginstitutions and refinancing institutions (FI’s) +Term borrowing by FI’s + Certificate of depositissued by FI’s L3 = L2 + Public deposits of non bankingfinancial companies



Monetary Policy of RBI

It is a regulatory policy by which RBImaintain its control over the supply of

money for the realization of generaleconomic goals.It is a policy that manages the supply

of money and addresses the demandside of the commodity market in aneconomy.



What is Monetary Policy

These factors include – › Money supply› Interest Rates, and› Inflation.Through which RBI seeks to ensure∞ Price stability,∞ Economic growth.∞ Full employment



Objective of Monetary Policy

Objectives of MonetaryPolicy

PriceStability

Credit Availability

FinancialStability

ExchangeRateStability

EconomicGrowth



Types of Monetary Policy

Expansionary Monetary Policy Aims at encouraging spending on goods & services by expanding

supply of credit and money by lowering the policy rates, loweringthe reserve requirements & purchasing the government securitiesin the market.

Contractionary (Tight) Monetary Policy Aims at preventing inflation by contracting the money

supply which is achieved by increasing policy rates,reserve requirements and selling the governmentsecurities in the market.

Countercyclical Monetary Policy Aims at moderating the cyclical fluctuations in the

economy and stabilizing the economy around its trendpath by following countercyclical measures.



Inflation:



Monetary Policy v/s FiscalPolicy

1. The Monetary Policyregulates the supply of

money and the cost andavailability of credit in theeconomy.

2. Aims at controlling theinflation.

3. Its control over the supplyof money & reduceinflationary pressure inthe economy

1. Deliberate changes

in Govt. revenues &expenditure2. Aims at full & price

level stability.3. Can be used to

overcome therecession & controlinflation

Monetary Policy Fiscal Policy



Interest Rates:

Interest is a fee paid by a borrower of assets to the owner as a form of compensation for theuse of the assets.

a) risk of principal loss, called credit risk ; andb) forgoing other investments that could have been

made with the loaned asset

http://en.wikipedia.org/wiki/Fee

http://en.wikipedia.org/wiki/Asset

http://en.wikipedia.org/wiki/Credit_risk

http://en.wikipedia.org/wiki/Investments

http://en.wikipedia.org/wiki/Investments

http://en.wikipedia.org/wiki/Credit_risk

http://en.wikipedia.org/wiki/Asset

http://en.wikipedia.org/wiki/Fee



Real interest rate

An interest rate that has been adjusted toremove the effects of inflation to reflect the realcost of funds to the borrower, and the real yield

to the lender.Real Interest Rate = Nominal Interest Rate -Inflation (Expected or Actual)



BPS

A basis point is a unit of measure used infinance to describe the percentage change inthe value or rate of a financial instrument.

indicate changes in rate of interest and otherfinancial instruments1 basis point is equal to 0.01%

when we say that repo rate has beenincreased by 25 bps, it means that the rate hasbeen increased by 0.25%.

http://www.investopedia.com/terms/b/basispoint.asp

http://www.investopedia.com/terms/b/basispoint.asp



Bank Rate – Discount Rate

It is the rate of interest which acentral bank charges on the loansand advances that it extends tocommercial banks and otherfinancial intermediaries without anysale of securitiesIt is generally for a longer period oftime. BR FBR CR M S

http://en.wikipedia.org/wiki/Interest_rate

http://en.wikipedia.org/wiki/Central_bank

http://en.wikipedia.org/wiki/Commercial_bank














Cash Reserve Ratio

Banks in India are required to hold acertain proportion of their deposits in theform of cash.However, actually Banks don’t hold theseas cash with themselves, but deposit suchcase with Reserve Bank of India (RBI). CRR RR ER CR Ms



SLR (Statutory Liquidity Ratio)

The minimum percentage of deposits thatthe bank has to maintain in form of gold,cash or other approved securities . Thus,we can say that it is ratio of cash andsome other approved securities toliabilities (deposits).

SLR RR ER CRMs



LAF

LAF is a monetary policy tool which allows banks toborrow money through repurchase agreements1998 Narsminam Committee on banking rector reforms,recommends LAF2000 RBI introduces full-fledged LAF.LAF helps banks to quickly borrow money incase of anyemergency or for adjusting in their SLR/CRRrequirementsUnder LAF, RBI auctions Government securities, startingat the repo and reverse repo rate.Minimum bidding amount is Rs.5 crore.

In LAF, money transaction is done via RTGS. So in this’



Open Market Operations

Outright

GS BR CR Ms

Types of Open MarketOperations

Outrigh

t

Repo

Sale and Purchaseof governmentsecurities

Sale and Purchase ofgovernment securities with anagreement to buyback or resell



Repo / Reverse Repo

Sale SecuritiesReceives Funds

Purchase SecuritiesPays Funds

RBI

RepurchaseSecurities

Payback Funds

Returns Securities

Gets Back Funds

RepoMarket

Banks

Reverse Repo



Repo Rate – Repurchase RateReverse Repo Rate

It is the rate at which banks borrow moneyfrom the central bank for short period byselling their securities (financial assets) tothe central bank with an agreement torepurchase it at a future date atpredetermined price .

Repo absorbed liquidity REPO IR RR ERMs

Reverse repo injected liquidity



Bank Rate v/s Repo Rate

Bank rate is the rate

at which banksborrow money fromthe central bankwithout any sale ofsecurities.It is generally for alonger period oftime

Repo rate or

repurchase rate isthe rate at whichbanks borrowmoney from thecentral bank byselling theirsecurities.It is generally for a

short period of

Bank Rate Repo Rate



Marginal standing Facility

Effective from 9 th May 2011Policy Statement:

The stance of monetary policy is, among otherthings, to manage liquidity to ensure that itremain broadly in balance with neither a largesurplus diluting monetary transmission nor a

large deficit choking off fund flows.Introduce to sterilize the impact of large foreigncapital flow



Marginal Standing FacilityRate

Under this scheme, Banks will be able toborrow up to 2% of their respective NetDemand and Time Liabilities ― The rate of interest on the amountaccessed from this facility will be 300basis points (i.e. 3%) above the repo ratewef 15/07/2013This scheme is likely to reduce volatility inthe overnight rates and improve monetary

transmission.



Bank Rate 10.25% (w.e.f.15/07/2013

Increased from 8.25%which was continuing

since 03/05/2013

CRR 4.00% (wef 09/02/2013)-announced on29/01/2013

Decreased from4.25%which wascontinuing since

30/10/2012

SLR 23%(w.e.f. 11/08/2012)(announced on

31/07/2012)

Decreased from 24%which was continuing

since 18/12/2010Repo Rate under LAF 7.25% (w.e.f.03/05/2013) Decreased from 7.50%

which was continuingsince 19/03/2013

Rev Repo under LAF 6.25% (w.e.f. 03/05/2013 Decreased from 6.50%which was continuing

since 19/03/2013

Marginal StandingFacility (MSF)

10.25% (w.e.f.15/07/2013)

Increased from 8.25%which was continuing

since 03/05/2013



A Stylized Central Bank BalanceSheet

1. Paid up capital

2. Reserves3. Currency4. Banks deposits

with central Bank5. Government

Deposits6. Other liabilities

1. Loans & AdvancesGovernmentBanksOthers

2. InvestmentGovernment Securities

Foreign assets3. Gold4. Other assets

Liabilities Assets



Bank Behavior MIS

Profit

Maximization

Constrained Profit Maximization

Investment tatpay High

Interest Rate &is Default Free

Investment insome Liquid

Securities evenwith some what

lower return

RegulatoryConstraint

LiquidityConstraint



A stylized Balance Sheet ofCommercial Bank

Monetary LiabilitiesDemand DepositsFixed DepositsBorrowingsNon MonetaryLiabilitiesPaid UP CapitalReservesOther Liabilities

Financial AssetsNon earning Assets

(Reserves)Cash in handDeposit with central bank

Earning AssetsCredit To Govt.Credit to Pvt SectorOther Investment

Physical Assets

Liabilities Assets



RISK MANAGEMENT



Risk and Return

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Essential components of riskmanagement

Management of Risk Identify all areas of risk Evaluate/Assessment of these risks Prioritization of risks Set various exposure limits for different typeof business

Issue clear policy guidelines / directives.Measures to mitigate it.



Value at Risk (VaR)

Traded Market Risk Calculated using Value atRisk (VaR) methodology.1. Generation of management Information &

oversight,2. setting up of limits and triggers,3. Control of trading operations,4. Performance evaluation5. Regulatory reporting & risk oversight



OPERATIONA L RISK (OR)

Operational risk has been defined by the BaselCommittee on Banking Supervision1―As the risk of loss resulting from

inadequate or failed internal processes,people and systems or from externalevents ”.



OPERATIONA L RISK (OR)

• People: Internal failure to comply withemployments laws.

• Processes : workplace safety standards, policy

breaches, compliance breaches, key personnelrisks, damage to physical assets, businessdisruptions.

• Systems : system failures, transaction processing

failures, information security breaches and the like.• External factors : external fraud. Eg: robbery,

forgery, earthquake.



Liqu id i ty Risk

Liquidity risk is the potential inability to meetthe liabilities as they become due.It arises when the banks are unable to

generate cash to cope with a decline indeposits or increase in assets.It originates from the mismatches in the

maturity pattern of assets and liabilities.



Managing Liquidity Risk

Liquidity-adjusted value at riskLiquidity at risk: A country's liquidity positionunder a range of possible outcomes for

relevant financial variables ( exchange rates,commodity prices, credit spreads, etc. ) isconsidered.Scenario analysis-based contingency

plans: should incorporate events that couldrapidly affect an institution’s liquidity, includingtightening of collateral requirements orother restrictive terms associated with

secured borrowings,



Risk Managment

Enterprise Risk Governance

Economic Capital

Credit Risk•Credit Assessment

•Credit Analysis•Portfolio analysis

and management

Market Risk•Trading Risk•Interest rate &Currency risk intheBalance Sheet

Funding & Liquidity•Structural Funding &Liquidity Management•Scenario Stress Testing•Crises & Contingencyplanning

Operation Risk•InadequateProcess•Inadequate People•InadequateSystem•External Event



Why capital is required?

Banks require to maintain capital forthe risk that they carries in the book

Cushion against LossTo satisfy the regulatory minimum.To support future balance sheet

growth



Risk

Risk: The possibility of the occurrence ofthe event which will result in Loss1. Inability to predict the occurrence2. Undesirable consequences3. Want of banking business

Integral part of banking business: Calculated

Risk



Basel Accord

Basel I1988Only Credit

Risk

Internationallyoperating

BankCAR 8%

Indian BankCAR 9%

Basel II2004Credit + Market + Operational

Risk

Pillar - I

Pillar - II

Pillar - III

Credit Risk

MarketRisk

OperationalRisk

Basel III2009Quality,

Adequacy,Efficiency

Countercyclical

Provisions

Liquiditycoverage ratio

Net StabilityFunding Ratio

AvoidSystemic

Risks(StreesTesting



f l



Major Features of Basel III

A. Better Capital QualityB. Capital Conservation Buffer (Efficiency)C. Countercyclical Buffer (quality)D. Minimum Common Equity and Tier 1 Capital

RequirementsE. Leverage RatioF. Liquidity RatiosG. Systemically Important Financial Institutions

(SIFI)

ompar son o ap ad l d



p pRequirements under Basel II andBasel III



T L



Term Loan:

This credit facility is used to fulfil the long termrequirements of the borrower.The payback period for this facility varies from 3 to 10years.It is also called Secured Loans because the borrowerhas to furnish some security against this loan and thevalue of that security should be greater than or equalsto the loan amount.This credit facility can be used for the followingpurposes: -

Purchase of Plant & Machinery for the organizationPurchase of Land and building for a new or existingprojectsPurchase of other tools or instruments that are fixed innature i.e. furniture & fixtures, vehicles etc.

W ki C i l L



Working Capital Loan:

For financing temporary requirement of workingcapital, the organization can go for varioussources;a) Spontaneous Sources

I. Trade CreditII. O/S Exp’s

b) Commercial Paperc) Inter Corporate Deposits

d) BanksI. Cash CreditII. OverdraftIII. Bills Purchased / Discounted



N F d B d L di



Non Fund Based Lending

Letter of Credit

IssuerBank of Participant A

Participant A(Importer)

Letterof

Credit

Participant

B(Exporter)

monetory policy in india

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