Bank Rates and Monetary Policy Questions and Answers

Answer: B

Market Stabilisation Scheme(MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The mobilised cash is held in a separate government account with the Reserve Bank. The instrument thus has features of both, SLR and CRR

Answer: B

To meet additional liquidity requirements, banks can borrow overnight funds from the Reserve Bank under the Marginal Standing Facility (MSF) at a higher rate of interest. Banks can borrow against their excess SLR securities and are also permitted to dip down up to two percentage points below the prescribed SLR to avail funds under the MSF

Answer: C

Correct answer: Balance Accounts

"Balance accounts" is not a monetary policy instrument, or indeed a recognised term in this context.

The other three are the classical tools of a central bank. The discount rate - the bank rate in Indian usage - is the rate at which the central bank lends to banks. Open market operations buy and sell government securities to change the reserves in the system. Reserve requirements, the cash reserve and statutory liquidity ratios, oblige banks to hold a proportion of deposits in prescribed form.

Answer: B

Correct answer: INR 10

The RBI announced field trials of polymer notes in the ₹10 denomination.

Polymer substrate lasts several times longer than cotton-based paper, resists soiling and moisture, and accommodates security features such as transparent windows that paper cannot. The low denomination was chosen deliberately for trial: small notes circulate hardest and wear out fastest, so they show the durability benefit most clearly and represent the least risk if the trial disappoints.

Answer: B

Correct answer: Flow of Credit

Selling government securities takes cash out of the banking system: buyers pay the RBI and receive paper in exchange, so the banks' reserves fall. With smaller reserves they can support less lending, and the flow of credit contracts.

This is the contractionary use of open market operations, applied when inflation or excess liquidity needs restraining. It works quickly and can be finely graduated, unlike a change in the cash reserve ratio, which is blunt and applies to every bank at once.

Answer: D

Correct answer: All of the above

All three follow from raising the cash reserve ratio. Banks must hold a larger fraction of their deposits with the RBI, so less is available to lend; since lending creates deposits, the money supply contracts.

With less credit available its price rises, which is what the second option describes - demand for money now exceeds the reduced supply. And with less money chasing the same goods, inflationary pressure eases. The three statements are successive links in the same chain rather than alternatives, which is why the combined answer is correct.

Answer: D

Central Bank is following a tight money policy. When RBI increases the bank rate, the cost of borrowing for banks rises and this credit volume gets reduced leading to decline in supply of money. Thus, increase in Bank rate reflects tightening of RBI monetary policy.

Answer: A

Correct answer: FATF

The Financial Action Task Force is the inter-governmental body that sets standards against money laundering and terrorist financing, and it publishes lists of jurisdictions with strategic deficiencies in their regimes.

The RBI restricted Indian entities from investing in countries and territories identified by FATF as non-cooperative, so that Indian capital does not flow into jurisdictions where the source and destination of funds cannot be traced. Compliance also protects Indian banks' own correspondent relationships, which depend on their counterparties' confidence in their controls.

Answer: A

Correct answer: Statutory Liquidity Ratio

The statutory liquidity ratio is the proportion of net demand and time liabilities that a bank must hold in liquid assets on its own books - cash, gold and approved securities such as government paper.

It is distinct from the cash reserve ratio, which must be held as cash with the RBI and earns nothing. SLR assets remain the bank's own and earn a return, so the SLR is a lighter burden per unit, but at 38.5 per cent in 1991 it amounted to a large captive market for government borrowing - which is why the Narasimham Committee proposed cutting it to 25.

Answer: C

Correct answer: Scheduled Commercial Banks may cut their lending rates.

Reducing the statutory liquidity ratio releases funds that banks were obliged to hold in government securities, so more is available for commercial lending. With a larger supply of loanable funds, competition tends to push lending rates down.

The last option has the direction wrong: cutting the SLR increases liquidity, it does not reduce it. And the effects on GDP growth and foreign institutional investment are at best indirect and gradual - the word "drastically" is what makes those options wrong rather than the direction of the effect.