Monetary Policy & RBI Tools — Set 2

Correct Answer: B. 4% ±2%

The MPC has a mandated inflation target of 4% with a tolerance band of ±2%, meaning the acceptable range is 2% to 6%. This target is measured in terms of the Consumer Price Index (CPI) combined. If inflation stays outside this band for three consecutive quarters, the MPC must explain the reasons to the Government.

Correct Answer: B. RBI lends overnight to commercial banks

The correct answer is RBI lends overnight to commercial banks. The Repo Rate (Repurchase Option Rate) is the short-term interest rate at which the RBI lends money to commercial banks overnight against government securities as collateral. When RBI raises the Repo Rate, borrowing becomes expensive for banks, which in turn raise lending rates, reducing money supply and controlling inflation. This topic is frequently tested in competitive examinations such as RRB NTPC, SSC, and UPSC.

Correct Answer: A. Rate at which banks lend to RBI

The Reverse Repo Rate is the interest rate at which commercial banks park their excess funds with the RBI. It is typically 25 basis points (0.25%) lower than the Repo Rate. When RBI raises the Reverse Repo Rate, banks prefer to deposit more money with RBI rather than lending it out, which absorbs excess liquidity from the system.

Correct Answer: C. 25 bps above the Repo Rate

The Marginal Standing Facility (MSF) is an emergency overnight borrowing window for banks, set at 25 basis points (0.25%) above the Repo Rate. Banks can borrow under MSF even by dipping into their Statutory Liquidity Ratio (SLR) up to a certain limit. MSF was introduced in 2011 as part of the restructured Liquidity Adjustment Facility.

Correct Answer: B. Cash Reserve Ratio

CRR stands for Cash Reserve Ratio — the percentage of a bank's Net Demand and Time Liabilities (NDTL) that must be kept with the RBI as cash. CRR is a key monetary policy tool; when RBI increases CRR, banks have less money to lend, reducing money supply. No interest is paid by RBI on CRR balances.

Correct Answer: C. CRR is a percentage of NDTL kept with RBI as cash

The Cash Reserve Ratio (CRR) is a mandatory requirement where banks must maintain a specified percentage of their Net Demand and Time Liabilities (NDTL) as cash with the Reserve Bank of India. RBI does not pay any interest on CRR balances. Currently, the CRR is 4% of NDTL.

Correct Answer: C. Govt securities, cash, or gold

Under the Statutory Liquidity Ratio (SLR), banks are required to maintain a specified percentage of their NDTL in liquid assets — which include cash, gold, and approved government/RBI-approved securities. Currently, the SLR is 18% of NDTL. SLR ensures that banks always have a certain level of liquid assets available.

Correct Answer: C. 18%

The Statutory Liquidity Ratio (SLR) is currently 18% of Net Demand and Time Liabilities (NDTL). SLR was progressively reduced by RBI from its peak of 38.5% in the 1990s to the current level to give banks more flexibility to lend. Unlike CRR, SLR is maintained in the form of liquid assets such as government securities.

Correct Answer: B. Buying/selling government securities to manage liquidity

Open Market Operations (OMO) refer to the buying and selling of government securities by the RBI in the open market to regulate liquidity. When RBI buys government securities, it injects money into the system (expansionary). When RBI sells government securities, it absorbs liquidity from the system (contractionary). OMOs are a key tool for liquidity management.

Correct Answer: A. Liquidity Adjustment Facility

LAF stands for Liquidity Adjustment Facility, which is a monetary policy tool used by RBI to manage day-to-day liquidity in the banking system. The LAF consists of the repo rate (for borrowing by banks from RBI) and the reverse repo rate (for parking funds with RBI). It was introduced in 2000 and forms the core of the interest rate corridor.