Monetary policy is the ways and methods that central banks use to control the economy. It helps the central bank to maintain an adequate amount of money supply in the market. The money supply in the market grows rapidly, it will increase the inflation. On the other hand, if money supply is less, it will hamper the growth in the economy. We now confine ourselves to Reserve Bank of India as the central bank. There are different tools used by RBI to maintain the adequate supply. These tools can be divided into two parts as is shown above.
We now will try to explain some the terms used in monetary policy tools.
Cash Reserve Ratio: It is the minimum amount of money that the banks have to hold as reserve with the central bank. This is done to ensure that the banks have adequate amount of liquidity with them to meet the payment demand of their customers.
Statutory Liquidity Ratio: This is the minimum amount of reserve banks need to maintain in the form of cash, gold and government approved securities before lending to its customers.
Liquidity Adjustment Facility: This is used by banks to adjust their day to day mismatches. Here the banks are allowed to borrow money through repurchase agreement. Central and state governments, Banks and non-banking financial institutions (NBFI) lends and borrow money for adjusting their liquidity mismatch. The minimum amount that can be borrowed under this window is Rs5.00 Cr. Here the money is borrowed at repo rate.
Marginal Standing Facility: Under this facility, the scheduled commercial banks are allowed to borrow money from RBI at 1% higher than the ongoing Repo rate under Liquidity adjustment facility. The minimum bidding amount is fixed at Rs.1.00 Crore. Here the banks are also allowed the government securities which are part of their SLr quota. The maximum borrowing amount is fixed at 2% NDTL( Net Demand and Time Liability)
Bank Rate: This is the rate at which the banks are allowed to borrow from RBI for long term.
Net Demand and Time Liability:
Demand liabilities include money deposited in saving and current account, unclaimed deposits, etc. To simplify, it includes all that money which the customers can demand whenever the feel the need of it.
Time liability is where there is a fixed time scheduled for the money to mature and being demanded by the customer. This includes Fixed deposits, Cash certificates, security deposits, gold deposits, etc.