The instruments of Monetary Policy are categorised as Quantitative or Qualitative in nature. Quantitative instruments influence the volume of money and supply of credit in the system and include bank rate, open market operations and reserve ratio requirements. Qualitative instruments or Selective instruments affect the direction of credit supply in the economy. This is done through margin requirements, moral suasion, credit ceiling and discriminatory rates of interests.
Repo Rate, Bank Rate and Reverse Repo Rate
Lending money to and borrowing money from commercial banks in India, are the important activities of RBI to modulate supply of money in the market under the Monetary Policy Framework. Under expansionary monetary policy, RBI increases supply of money by lending money to commercial banks and decreases money supply by borrowing from the banks under contractionary monetary policy.
As normal commercial operations, interest is paid on borrowing and is charged on lending. A decrease in the Repo Rate encourages banks to borrow from RBI thereby making money and credit available at cheaper rate thus pushing the economic growth. However, reduction in Repo Rate may increase inflation. Hence RBI reduces Repo Rate only in such a situation when the inflation is well under control and a slight rise in it will not have any negative impact on the economy. Likewise, an increase in Repo Rate will make money and credit available at higher rate and decrease in supply of money in the market. While Repo Rate is for short term, Bank Rate is the long-term rate at which RBI lends money to banks or financial institutions. Currently, bank rate is not being used by RBI for monetary management.
RBI borrows money from commercial banks at Reverse Repo Rate. An increase in it will allure the banks to keep money with RBI, thereby decreasing money supply. A decrease in Reserve Repo Rate will discourage Banks from keeping money with the RBI thereby increasing availability of money, and it turn ensuring credit expansion.
In the current situation, Repo Rate has been reduced to a 15-year low of 4.00% and Reverse Repo Rate has been reduced to 3.35%. Bank Rate has been reduced to 4.25%.
(The views and opinions expressed in the article are solely of the author and not of the Bank).