RBI’s Monetary Policy Instruments

News: RBI has slashed the repo rate by a larger-than-expected 50 basis points to 5.50 per cent, marking the third consecutive reduction since February 2025. RBI’s Monetary Policy Instruments.

About RBI’s Monetary Policy Instruments and key takeaways from the latest monetary policy

Monetary Policy Instruments

• Repo Rate and Reverse Repo Rate: The interest rate that the RBI charges when commercial banks borrow money from it is called the repo rate.
  • The interest rate the central bank pays commercial banks when they park their excess cash is called the reverse repo rate.
• Standing Deposit Facility (SDF) Rate: It is the rate at which the RBI, on an overnight basis, accepts uncollateralised deposits from all liquidity adjustment facility (LAF) participants.
  • The SDF is also a financial stability tool in addition to its role in liquidity management.
  • It was introduced in 2022 to replace the fixed rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor.
• Marginal Standing Facility (MSF) Rate: It is the rate at which a bank can borrow, on an overnight basis, from the RBI in an emergency situation when inter-bank liquidity dries up completely.
  • It is typically placed at 25 basis points above the policy repo rate.
• Liquidity Adjustment Facility (LAF): LAF is a facility extended by RBI to the scheduled commercial banks (excluding Regional Rural Banks) and Primary Dealers to avail of liquidity in case of requirement or park excess funds with RBI in case of excess liquidity on an overnight basis against the collateral of G-Secs including State Development Loans (SDLs).
• Main Liquidity Management Tool: To manage the frictional liquidity requirements, a 14-day term repo/reverse repo auction operation at a variable rate is conducted to coincide with the cash reserve ratio (CRR) maintenance cycle.
• Bank Rate: In case of shortfalls in meeting the reserve requirements (cash reserve ratio and statutory liquidity ratio) by the banks, the Reserve Bank provides to buy or rediscount bills of exchange or other commercial papers at a rate which is called Bank rate.
• Cash Reserve Ratio (CRR): It is the percentage of a bank’s net demand and time liabilities (NDTL) that is required to be maintained in liquid cash with the RBI as a reserve.
  • The RBI determines the CRR percentage from time to time.
• Statutory Liquidity Ratio (SLR): Every bank is required to maintain in Indian assets, the value of which shall not be less than such percentage of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight, in the form of liquid cash, gold, government and state government securities.
• Open Market Operations (OMOs): These include outright purchase or sale of government securities by the Reserve Bank for injection or absorption of durable liquidity in the banking system.

Recent Decisions by the RBI Monetray Policy Committee

• The Reserve Bank of India’s six-member Monetary Policy Committee (MPC) has slashed the repo rate by a bigger-than-expected 50 basis points to 5.50 per cent, marking the third consecutive reduction since February 2025.
• The central bank also cut the cash reserve ratio of banks by 100 basis points to 3 per cent, releasing Rs 2.5 lakh crore of lendable resources to the banking system.

Impacts of Monetary Policy Instruments by the RBI

• Impact of reducing repo rate: When the RBI wants to encourage economic activity in the economy, it reduces the repo rate.
  • Doing this enables commercial banks to bring down the interest rates they charge (on their loans) as well as the interest rate they pay on deposits, incentivising people to spend money, and businesses to take new loans a little less cost.
• Impact of increasing repo rate: When the RBI wants to control inflation, it increases the repo rate.
  • Banks thus have to pay more interest to borrow from the RBI, which means they will charge more interest to their borrowers, disincentivising people from borrowing money.