RBI uses its monetary policy for controlling inflationary or deflationary situations in the economy by using one or more of the following tools of monetary control. These are discussed below.

1. Cash Reserve Ratio (CRR)

It refers to the cash that all banks (scheduled and non-scheduled) are required to maintain with RBI as a certain percentage of their demand and time liabilities (DTL). As you know, demand liabilities of a bank represent its deposits which are payable on demand of the depositors (viz., current and savings deposits) and time liabilities refer to its time deposits which are repayable on the specified maturities. In order to meet these liabilities in time (i.e. to keep liquidity), a bank has to keep a regulatory cash reserve with RBI (currently, it is 6.5 per cent for scheduled commercial banks). If a bank fails to maintain the prescribed CRR at prescribed intervals, it has to pay penal interest on the shortfall by adjustment from the interest receivable on the balances with RBI. A cut in the CRR enhances loanable funds with banks and reduces their dependence on the call and term money market. This will bring down the call rates. An increase in CRR will squeeze the liquidity in the banking system and reduce their lending operations and the call rate will tend to increase.

2  Statutory Liquidity Ratio (SLR)

It refers to the supplementary liquid reserve requirements of banks, in addition to CRR. SLR is maintained by all banks (scheduled and non-scheduled) in the form of cash in hand (exclusive of the minimum CRR), current account balances with SBI and other public sector commercial banks, unencumbered approved securities and gold. RBI can prescribe SLR from 0 per cent to 40 per cent of bank's DTL (presently it is 25 per cent). SLR has three objectives:

           To restrict expansion of banks' credit,

           To increase banks' investment in approved securities and

           To ensure solvency of banks.






The effect of an increase in SLR by RBI is the reduction in the lending capacity of banks by pre-empting (blocking) a certain portion of their DTL for government or other approved securities. It has therefore a deflationary impact on the economy, not only by reducing the supply of loanable funds of banks, but also by increasing the lending rates in the face of an increasing demand for bank credit. The reverse phenomena happens in case of a cut in SLR.

3  Bank Rate

Bank Rate is the standard rate at which RBI is prepared to buy or rediscount bills of exchange or other eligible commercial paper from banks. It is the basic cost of rediscounting and refinance facilities from RBI. The Bank Rate is therefore used by RBI to affect the cost and availability of refinance and to change the loanable resources of banks and other financial institutions. Change in the Bank Rate by RBI affects the interest rates on loans and deposits in the banking system across the board in the same direction, if not to the same extent. After deregulation and banking reforms since 1991, RBI has gradually loosened its direct regulation of deposit and lending rates and these are left to banks to decide through their boards, with only a few exceptions. However, RBI can still affect the interest rates via changes in its Bank Rate, whenever the situation of the economy warrants it.

4  Open Market Operations (OMOs)

This refers to sale or purchase of government securities (of Central or State governments or both) by RBI in the open market with a view to increase or decrease the liquidity in the banking system and thereby affect the loanable funds with banks. RBI can also alter the interest rate structure through its pricing policy for open market sale/purchase.

5  Selective Credit Control (SCC)

The RBI issues directives, under Sections 21 and 35A of the Banking Regulation Act, stipulating certain restrictions on bank advances against specified sensitive commodities as follows:

Pulses, other food grains (viz., coarse grains), oilseeds, oils including vanaspati, all imported oil seeds and oils, sugar including imported sugar (excepting buffer stocks and unreleased stock of sugar with sugar mills), Gur and Khandsari, Cotton and Kapas, Paddy/Rice and Wheat.

RBI's objective in issuing Selective Credit Control (SCC) directives is to prevent speculative holding of essential commodities and the resultant rise in their prices. RBI's general guidelines on SCC are:

(i)                 anks should not allow customers dealing in SCC commodities any credit facilities including against book debts/receivables or even collateral securities like insurance policies, shares, stocks and real estate) that would directly or indirectly defeat the purpose of the SCC directives,

(ii) Credit limits against each commodity covered by SCC directives should be segregated and the SCC restrictions be applied to each of such segregated limits.

Presently, only buffer stocks of sugar, unreleased stocks of sugar with sugar mills representing free sale sugar and levy sugar are covered by SCC directives.


RBI has used other tools of regulation in the past. However, after the liberalisation policy of 1991, most of these tools have since been discontinued and are no longer used by RBI. These tools are:

           Credit Rationing/Allocation      Credit Authorisation Scheme

           Credit Planning              Inventory and Credit Norms


There are certain regulatory restrictions on lending by banks in terms of RBI directives or the Banking Regulation Act, 1949 (BRA) as follows:

i) No advance or loan can be granted against the security of the bank's own shares or partly paid shares of a company,

ii) No bank can hold shares in a company:

a) As pledgee or mortgagee in excess of the limit of 30 per cent of the Paid-up capital of that company or 30 per cent of the Bank's Paid-up capital and Reserves, whichever is less (Sec. 19(ii) of BRA).

b) in the management of which Managing Director or Manager of the Bank is interested (Sec. 19(iii) of BRA).

iii) Bank's aggregate investment in shares, Certificate of Deposits (CDs), bonds, etc., should not exceed the limit of 40 per cent of Bank's net owned funds as at the end of the previous year,

iv) No bank should grant loans against:

a)         CDs

b)         FDs issued by other banks

c)         Money Market Mutual Funds

(v) Bank should adhere to the RBI guidelines relating to the level of credit, margin and interest rate etc. for loans against the security of commodities covered by the Selective Credit Control Directives of RBI. No loan should be granted by banks to:

• The Bank's directors or firms in which a director is interested as a partner/manager/employee/guarantor (certain exemptions allowed).

           Relatives of other bank's directors ('relatives' defined by RBI) - Such loans can be sanctioned by higher authorities or the Bank's Board as per RBI guidelines.

vi) Banks should not sanction a new or additional facility to borrowers appearing in RBI's list of "Willful Defaulters" for a period of 5 years from the date of publication of the list by RBI.


Reserve Bank of India is the central banking authority and regulator of the Indian Banking System, like the Federal Reserve Board in USA and Bank of England in UK. RBI was constituted under the Reserve Bank of India Act, 1934 and it draws its regulatory powers from this Act and also the Banking Regulation Act. RBI's main objectives are to maintain financial solvency and liquidity in the banking system,stability in the exchange rate and internal value of the Rupee, to regulate the volume and flow of bank credit in tune with the national priorities and to develop financial institutions on sound lines.

RBI performs multifarious functions to achieve the above said objectives. Its main functions include Notes Issuance, Government's Banker, Bankers' Bank, Banks' Supervision, Development of the Financial System, Exchange Control, and Monetary Control.

RBI's main tools of Monetary Control are Cash Reserve Ratio, Statutory Liquidity Ratio, Open Market Operations, Bank Rate and Selective Credit Control. RBI uses these tools singly or in combination to control and rectify specific monetary situations in the economy or banking system from time to time. These measures affect the volume and cost of bank credit, besides maintaining the stability of the financial system.

In accordance with the government policy of poverty alleviation and improving the economic condition of the disadvantaged sections of the society, RBI has directed banks to lend to the specified Priority Sector with a minimum target of 40 per cent of their Net bank credit, with specified sub-targets for agriculture, weaker sections and the very poor sections of the society. Certain concessions in the lending terms and operations have also been prescribed by RBI for Priority Sector Advances.

There are also certain regulatory restrictions prescribed by RBI on lending by banks in terms of the Banking Regulation Act and also on grounds of prudence and to prevent abuse of bank credit.


(c): Online materials

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