7 Monetary Policy Tools in hands of RBI & Effects

(1) Cash Reserve Ratio

CRR is the minimum percentage of deposits with commercial banks that they need to deposit with central bank of RBI.

Present CRR = 4 %

(A) Impact of increased CRR

Positive impact - It is a quick fix to control inflation. By increasing CRR, commercial banks need to deposit more money with RBI. 

Thus commercial banks left with less money. Now loans become dearer, so people have less money. 

As 

Less money with Commercial banks → Less money with people → Lower demand for goods and services → Lower prices

Higher CRR simply sucks money from the economy.

(B) Impact of decreased CRR

More money with Commercial banks → More money with people → Higher demand for good sand services → Higher prices 

CRR should be aligned with supply and production levels. If people are producing more then they deserve to spend more. Decreased CRR provides a short term fix as it increases demand for short term.

(2) Statutory Liquidity Ratio

It is the percentage of liabilities and time deposits that commercial banks need to keep with them in form of cash, gold or government approved securities. 

Present SLR = 21.5%

(A) Impact of increase in SLR

Commercial banks need to keep more liquid funds → Provides less loans to people → Lower demand for goods and services → Lower prices 

(B) Impact on decrease in SLR

Commercial banks need to keep less liquid funds → Provides more loans to people → Higher demand for goods and services → Higher prices

(3) Repo rate

It is the Rate at which RBI lends money to commercial banks against securities in case commercial banks fall short of funds.

Present Repo Rate = 6.75%

Impact :- 

(IA) If RBI Increase Repo Rate, it becomes costly for banks to borrow money from RBI so they in turn hike the rates at which customers borrow money from them to compensate for the hike in repo rate. This will discourage customers from taking loans.

(IB) It also decreases supply of money in markets.

(IIA) If RBI Decreases its Repo Rate, it becomes costly for banks to borrow money from RBI so they in turn hike the rates at which customers borrow money from them to compensate for the hike in repo rate. 

This will encourage customers for taking loans.

(IIB) It also increases supply of money in markets.

(4) Reverse Repo Rate

It is the Rate at which RBI borrows money from commercial banks.

Present  Reverse Repo Rate = 5.75%

Impact 

(I) An increase in the reverse repo rate will decrease the money supply and vice-versa, other things remaining constant. 

An increase in reverse repo rate means that commercial banks will get more incentives to park their funds with the RBI, thereby decreasing the supply of money in the market.

(II) If commercial banks get more money they will lend more money to people which will lead more demand in economy. Thus prices will increase.

NOTE - Due to these, lending and investment rates of banks changes. This is the only direct way in which Repo Rate and Reverse Repo Rate can affect a common man. 

Loan interest rate and Deposit interest rate fluctuate.

(5) Bank rate

It is a rate at which RBI lends money to commercial banks without any security (i.e No Selling / Buying of Security). 

Present  Bank rate = 7.75%

Impact

When bank rate is increased interest rate also increases which have negative impact on demand thus prices increases.

(6) Marginal Standing Funding

By this mechanism commercial banks can get loans from RBI for their emergency needs. 

Commercial banks can take loan only upto 1% of their liabilities and time deposits. 

Present  MSF Rate  = 7.75%

(7) Open Market Operations

Buying and selling government securities and bonds in order to manage liquidity in the economy.

(i) Impact of Purchasing Securities

More money in economy → More demand → Higher growth rate

(ii) Impact of Selling Securities

Less money in economy → Less demand → Lower prices