Banking and Monetary Policy

📘 AFCAT Economics · ECA03 ✈️ AFCAT Level : High Priority

Banking & Monetary Policy is a direct scoring AFCAT chapter. Know the RBI tools, their current values, and what each does to money supply. Questions are definition-based.

📌 AFCAT Pattern: RBI = central bank • Repo Rate definition • CRR and SLR distinction • OMO • Monetary policy goal • Current rate values

RBI & Monetary Policy Tools

RBI (Reserve Bank of India): Central bank of India. Established 1935 (nationalised 1949). HQ: Mumbai. Governor: Sanjay Malhotra (Dec 2024). Functions: Issues currency; controls money supply; banker to government; lender of last resort; manages forex reserves.
Monetary Policy: RBI’s use of tools to control money supply and inflation. Decided by MPC (Monetary Policy Committee — 6 members). CPI target: 4% (±2%).
Repo Rate (6.25%): Rate at which RBI lends short-term money to commercial banks. Rise → costlier credit → inflation controlled (contractionary). Cut → cheaper credit → growth stimulated (expansionary). Cut in Feb 2025 = first since May 2020.
Reverse Repo Rate (3.35%): Rate at which RBI borrows from commercial banks (banks park excess funds with RBI).
CRR (Cash Reserve Ratio = 4.0%): % of total deposits that banks must keep as cash with RBI. Earns NO interest for banks. Rise → less to lend → money supply falls.
SLR (Statutory Liquidity Ratio = 18.0%): % of deposits banks must hold in liquid assets (gold, government securities). Rise → less to lend → credit contracts.
OMO (Open Market Operations): RBI buys government securities from banks → injects cash → money supply rises. RBI sells → absorbs cash → money supply falls.

📝 AFCAT PYQBanking & Monetary Policy — AFCAT Pattern

Q1. What is the Repo Rate? (AFCAT I 2023)

(a) Rate at which RBI borrows from banks (b) Rate at which commercial banks lend to public (c) Rate at which RBI lends to commercial banks (d) Rate on savings accounts

Answer: (c) Rate at which RBI lends to commercial banks
Repo (Repurchase Agreement) Rate = RBI lends overnight to commercial banks against government securities as collateral. Currently 6.25% (cut Feb 2025). When Repo falls, banks get cheaper funds → pass on lower rates to customers → economy stimulated. Reverse Repo = RBI borrows FROM banks.

Q2. SLR refers to: (AFCAT II 2022)

(a) % of deposits kept as cash with RBI (b) % of deposits held in gold/govt securities (c) Rate at which banks lend to each other (d) % of profit banks give to RBI

Answer: (b) % of deposits banks must hold in liquid assets (gold or government securities)
SLR (Statutory Liquidity Ratio) = 18.0% currently. Banks must hold this proportion of their demand and time liabilities in approved liquid assets (govt securities, gold). Unlike CRR (kept as cash with RBI), SLR assets earn returns for banks. Rise in SLR reduces funds available for lending.

Q3. When RBI buys government securities in the open market, the effect is: (AFCAT I 2024)

(a) Money supply falls (b) Money supply rises (c) Inflation is immediately controlled (d) Government borrowing increases

Answer: (b) Money supply rises
OMO: When RBI buys govt securities from banks/public → pays money → cash injected into economy → money supply rises → expansionary. When RBI sells govt securities → receives money → cash absorbed → money supply falls → contractionary. Used when RBI wants to manage short-term liquidity in the banking system.

📝 Rapid Revision — ECA03

🏭 RBI Tools (Current Values)

Repo: 6.25% (lends to banks; Feb 2025 cut)
Reverse Repo: 3.35% (borrows from banks)
CRR: 4.0% (cash with RBI; zero interest)
SLR: 18.0% (gold + govt securities)
OMO: buy = inject; sell = absorb

🚫 AFCAT Traps

Repo = RBI lends (NOT borrows)
Reverse Repo = RBI borrows (NOT lends)
CRR earns NO interest for banks
OMO buy = money supply UP
CPI = RBI target (4% ±2%); NOT WPI

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