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Quantitative Methods of RBI Credit Control

Posted by: BeenaaManivannan on 3:52 PM Categories:
1. Bank Rate Policy:

The standard rate at which the RBI is prepared to buy or rediscount bills of exchange or other commercial papers eligible for purchase under the provisions of the Act of RBI. Thus the RBI, rediscounts the first class bills in the hands of commercial banks to provide them with liquidity in case of need. This rate is subjected to change from time to time in accordance with the economic stability and its credibility of the nation. The bank rate signals the central bank’s long-term outlook on interest rates. If the bank rate moves up, long-term interest rates also tend to move up, and vice-versa.

Banks make a profit by borrowing at a lower rate and lending the same funds at a higher rate of interest. If the RBI hikes the bank rate (this is currently 6 per cent), the interest that a bank pays for borrowing money (banks borrow money either from each other or from the RBI) increases. It, in turn, hikes its own lending rates to ensure it continues to make a profit.

2. Open Market Operation:

It means of implementing monetary policy by which a central bank controls the short term interest rate and the supply of base money in an economy, and thus indirectly the total money supply. In times of inflation, RBI sells securities to mop up the excess money in the market. Similarly, to increase the supply of money, RBI purchases securities.

3. Adjusting with CRR and SLR:


By adjusting the CRR(Cash Reserve Ratio) and SLR(Statutory Liquidity Ratio) which are short term tools to be used to shortly regulate the cash and fund flows in the hands of the People, banks and Government, the RBI regularly make necessary adjustments in these rates. These variations in the rates will easily have a greater control over the cash flow of the country.

i) CRR(Cash Reserve Ratio):
All commercial banks are required to keep a certain amount of its deposits in cash with RBI. This percentage is called the cash reserve ratio. The current CRR requirement is 8 per cent. This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation by tying their hands in lending money.
ii) SLR(Statutory Liquidity Ratio): Banks in India are required to maintain 25 per cent of their demand and time liabilities in government securities and certain approved securities. What SLR does is again restrict the bank’s leverage in pumping more money into the economy by investing a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements.

4. Lending Rate:


Lending rates are the ratios fixed by RBI to lend the money to the customers on the basis of those rates. The higher the rate means the credit to the customers is costlier. The lower the rate means the credit to the customers is less which will encourage the customers to borrow money from the banks more that will facilitate the more money flow in the hands of the public.

5. Repo Rate:


Repo rate is the rate at which banks borrow funds from the RBI to meet the gap between the demand they are facing for money (loans) and how much they have on hand to lend.

If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

6. Reverse Repo Rate:


The rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed the reverse repo rate. The RBI uses this tool when it feels there is too much money floating in the banking system.

If the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer them a lucrative rate of interest. As a result, banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain amount of risk)