RBI credit and monetary policy

We sometimes read the headlines in the newspaper and everyone keeps talking about the RBI credit policy. What is this? How does it impact us? We read that Banks are either happy or sad. So does it only impact Banks? Since the guidelines are given by the central bank, it is usually directed towards the Banks which have to follow the guidelines or mandates of the central bank i.e. the RBI.

The guidelines or mandates given by the RBI have an impact on the way the Bank operates. Now a Bank is not a charitable institution, it is there to make profit. So if there is a even a small change in the way it is asked to operate, it will have an impact on the banks profitability. How?

But before we go to how, let us see what are the considerations based on which the RBI policy is guided. The RBI policy considers the following:

1) Inpact on liquidity and monetary projections – The Reserve Bank has multiple instruments at its command such as repo and reverse repo rates, cash reserve ratio (CRR), statutory liquidity ratio (SLR), open market operations, including the market stabilisation scheme (MSS) and the LAF, special market operations, and sector-specific liquidity facilities. In addition, the Reserve Bank also uses prudential tools to modulate flow of credit to certain sectors consistent with financial stability. The availability of multiple instruments and flexible use of these instruments in the implementation of monetary policy has enabled the Reserve Bank to modulate the liquidity and interest rate conditions amidst uncertain global macroeconomic conditions. Let me give you an example on liquidity and interest rates by using SLR. If the SLR is increased the banks will have less money to lend, but have to maintain its profitability. So Banks will increase their interest rates. If its reduces, the amount of money available to lend will increase, which they would want to lend, but with high interest rates there will be no takers, so Banks will reduce the interest rates, since banks don’t make money if money is left idle.

2) Growth and Inflation Projections - Inputs are taken from various sections to see what would be the impact on the growth projection of the country. Example: Inputs are taken from the Indian Meteorological Department on the monsoon forecast and if the monsoon forecasts are expected to be poor in the northern region, then there is an expectation of poor commodity output which would push up prices. So it would put measure for lending to these sectors or reducing the lending rates to these sectors which will help in lowering the prices.

RBI also controls how the interest is paid on the balance in your saving bank account. Till now interest was always given on the lowest balance in your account between 10^th and the end of the month. Now from April 1, 2010 interest will be calculated on daily balance.

Now what we have seen is only with relation to Banks, but the credit policy has an impact on the whole market. The policy contains measures on the Financial Markets like the money market, government securities market and the foreign exchange market by defining guidelines for these markets as well.

Other than Banks and Financial Markets, it also gives policy guidelines on Payment and settlement system, Co-operative Banks and Non-Banking financial institutions

So the policy does have impact on us. Since anything and everything we do costs money and RBI defines what should be the cost of this money. Yes, they all say ultimately it is demand and supply. But RBI can still control the costs.