Money and Banking (part – II)

Reserve Bank of India (RBI) periodically intervenes in the debt market to influence the interest rates and rate of inflation in the economy. If RBI feels inflation is too high, it will sell government securities, and suck money out of the system. On the other hand, if RBI feels the economy is heading towards a recession, it will buy government securities from the banks, and inject money into the system. Hence, statement 1 is incorrect.

RBI also intervenes periodically in foreign exchange markets. If the rupee is rapidly depreciating, RBI will sell dollars in the market. This will increase the supply of dollars and the demand for rupees, causing the rupee price of the dollar to come down. On the contrary, if the rupee is rapidly appreciating, RBI will buy dollars and inject rupees into the economy. Hence, statement 2 is correct.

Interest rate movements in a foreign economy can also stimulate action on the part of RBI. If interest rates in the USA or the EU were to fall, FIIs will ramp up investments in India. The resultant demand for rupees will cause the rupee to appreciate. Then, that is likely to induce RBI to buy dollars and inject rupees into the system. Hence, statement 3 is also correct.

'Statutory Reserve Requirements' (SRR) is a minimum percentage of deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities. It is basically the reserve requirements that banks are expected to keep before offering credit to customers. The SRR is fixed by the Central Bank. SRR is the traditional tool of the Central Bank's monetary policy to control credit growth. Other statements are not among the purposes of the SRR. Hence, option (a) is the correct answer.

Statutory Liquidity Ratio or SLR is a minimum percentage of deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities. It is basically the reserve requirement that banks are expected to keep before offering credit to customers. These are not reserved with the Reserve Bank of India (RBI), but with banks themselves. The SLR is fixed by the RBI. CRR (Cash Reserve Ratio) and SLR have been the traditional tools of the Central Bank's monetary policy to control credit growth, flow of liquidity and inflation in the economy. The SLR was prescribed by Section 24 (2A) of Banking Regulation Act, 1949. The government uses the SLR to regulate inflation and liquidity. Increasing the SLR will control inflation in the economy while decreasing it will cause growth in the economy. Although, the SLR is a monetary policy instrument of RBI, it is important for the government to make its debt management programme successful. SLR has helped the government to sell its securities or debt instruments to banks. Most of the banks will be keeping their SLR in the form of government securities as it will earn them an interest income.

Cash Reserve Ratio is the percentage of the deposit (NDTL: Net Demand and Time Liabilities) that a bank has to keep with the RBI. CRR is kept in the form of cash and that also with the RBI. No interest is paid on such reserves, On the other hand, SLR is the percentage of deposit that the banks have to keep as liquid assets in their own vault. The CRR is a more active and useful monetary policy tool compared to the SLR. Usually, the RBI changes CRR to manage liquidity in the economy.

Statutory Liquidity Ratio (SLR) is a minimum percentage of deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities. It is basically the reserve requirement that banks are expected to keep before offering credit to customers. If the RBI reduces the SLR by 50 basis points, then commercial banks have more liquid cash to offer credit to customers. In this situation, commercial banks may cut their lending rates to promote credit creation

Statutory Liquidity Ratio (SLR) is a minimum percentage of deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities. It is basically the reserve requirement that banks are expected to keep before offering credit to customers. If the RBI reduces the SLR by 50 basis points, then commercial banks have more liquid cash to offer credit to customers. In this situation, commercial banks may cut their lending rates to promote credit creation

P.L.R. is not determined by the Reserve Bank of India. The Prime Lending Rate (P.L.R.) is the interest rate that commercial banks charge to their most creditworthy corporate customers.

Marginal Standing Facility' (MSF) is a facility under which scheduled commercial banks can borrow additional amount of overnight money from the RBI by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system. MSF rate is an instrument used for implementing monetary policy. It is noteworthy that Bank Rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes. Net Demand and Time Liabilities' (NDTL) refers to the total demand and time liabilities (deposits) of the public that are held by the banks with other banks. NDTL shows the difference between the sum of demand and time liabilities (deposits) of a bank (with the public or the other bank) and the deposits in the form of assets held by the other bank.

Statutory Liquidity Ratio (SLR) is a minimum percentage of 221. Since deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities before offering credit to customers. RBI increases the SLR to reduce credit growth during the time of inflation and cut and optimize the SLR during the period of recession to increase credit. Hence, statement 1 is incorrect.

Marginal Standing Facility (MSF) Rate is a window for commercial banks to borrow funds overnight from the RBI against approved government securities. Increasing the MSF will make borrowing costly, which is against the expansionist monetary policy of the RBI. Hence, statement 2 is correct.

RBI cuts the Bank Rate and Repo Rate to increase the liquidity in the market. It comes under the RBI's expansionist monetary policy. Hence, statement 3 is incorrect.

If the interest rate is decreased in an economy, it will increase consumption and investment expenditure in the economy, because at low interest rate borrowing becomes easy and people tend towards investment and consumption expenditure. Hence, option (c) is the correct answer.

The financial sector reforms refer to step taken by the Government to reform the banking system, capital marker, government debt market, foreign exchange market etc. The financial sector reforms in India mainly consist of :

• Lowering down of CRR and SLR
• Deregulation of deposits and lending interest rates
• Entry of private firms in banking and insurance sector
• Reforms related to non-performing assets (NPA)
• Elimination of direct or selective credit controls.

Hence, option (d) is the correct answer.