Quantitative tools also known as the Reserve Bank of India’s general tools are instruments linked to the quantity and volume of money, as the name implies. These instruments are used to regulate the total amount of money and volume of bank credit in the economy. Cash Reserve Ratio, Statutory Liquidity Ratio, Open Market Operations and Repo Rate are a few examples of Qualitative tools of Monetary Policy.

In this article, let us see the meaning of quantitative tools, different quantitative tools available under the monetary policy and their relationship with liquidity.

What are Quantitative tools/Quantitative instruments?

• The Quantitative tools are also known as the Reserve Bank of India’s general tools.
• These instruments are linked to the quantity and volume of money, as the name implies.
• These instruments are used to regulate the total amount of money and volume of bank credit in the economy.
• These are indirect instruments that are used to influence the amount of credit available in the economy.
• For instance, reducing the Statutory Liquidity Rate (SLR) will increase the liquidity of money in the market and increasing the SLR will decrease the liquidity.

Different Quantitative tools

There are many quantitative tools available with the RBI to control the volume of money and liquidity under its monetary policy. They are as follows,

Bank Rate

• Bank Rate is the interest rate at which the Reserve Bank of India (RBI) lends money to domestic/commercial banks, usually in the form of relatively short-term loans.
• Commercial banks are not required to keep any collateral as security when borrowing at Bank Rate.
• There is no repurchasing agreement and obligation to repay on a particular date.
• Section 49 of the Reserve Bank of India Act, 1934, governs the publication of the Bank Rate.
• This rate is linked to the MSF rate, therefore it adjusts automatically when the MSF rate changes, as well as when the policy repo rate changes.
• As of December 2021 monetary policy, the Bank rate is 4.25%.

Statutory Liquidity Ratio (SLR)

• Statutory Liquidity Ratio (SLR) is the minimum percentage of deposits (ie. Net Demand and Time Liabilities (NDTL)) that a commercial bank must keep with itself.
• This asset can be in the form of the following:
  • Cash
  • Gold valued at a price not exceeding the current price
  • Government securities and Treasury Bills
• Note: In the case of securities, the bank can only hold government securities and can not invest in any private stocks.
• The Reserve Bank of India is authorized to set SLR and change it with changing macroeconomic conditions.
• To keep bank credit under control, the Reserve Bank of India raises the SLR as inflation rises. During a recession, the RBI lowers the SLR to promote bank credit.
• The CRR (Cash Reserve Ratio) and SLR (Stock Liquidity Ratio) have long been used by central banks to limit credit growth, liquidity flow, and inflation in the economy.
• A bank is liable to pay a penalty to the Reserve Bank of India if it fails to maintain the prescribed SLR. On the deficient amount for that particular day, the defaulter bank must pay a penalty of 3% above the bank rate.
• The 2007 amendment to the Banking Regulation Act of 1949 removed the lower ceiling of SLR which implied it can be sr between 0-40% of NDTL of the banks.
• As of December 2021, the SLR is at 18.00% of the NDTL of the banks.

Cash Reserve Ratio

• The Cash Reserve Ratio (CRR) is the minimum percentage of total deposits (ie. NDTL) that a commercial bank is required to retain as cash reserves with the RBI.
• It has to be in the form of Cash.
• It is applicable to all Scheduled commercial banks.
• For Instance, let us consider that Bank A has received 100 Crores as Deposits. If we have a CRR of 3% then Bank A has to deposit 3 crores in Cash form with the RBI and are left with 97 crores for its operation.
• When a central bank raises the CRR, the amount of money accessible to banks reduces or falls and vice-versa.
• It has to be placed in a vault in the bank or placed with the RBI.
• The RBI Act 1949, Section 42 gave a provision for the RBI to announce a CRR between 3%-15%. This was amended in 2007 by removing the lower ceiling making it 0-15%.
• As of December 2021, the CRR is maintained at 3%.

Open Market Operation (OMO)

• Open Market Operations (OMO) is the selling and purchase of government securities and treasury bills by the RBI.
• Selling of G-Secs by RBI will reduce the liquidity in the market and Buying of G-Secs by RBI will increase the liquidity.
• All Scheduled Commercial Banks and Financial institutions can participate in OMO.
• The RBI has allowed even the retail investors to invest in G-secs by opening gilt accounts with the Central Bank.
• In April 2021, the RBI performed a simultaneous buying and selling of Government securities through Open Market Operations of nearly Rs. 10000 crores each.

Liquidity Adjustment facility

• It is a monetary policy tool used largely by the Reserve Bank of India (RBI) that controls the liquidity or money supply in the economy.
• It does it by either allowing banks to borrow money via repurchase agreements (repos) or lend loans to the RBI via reverse repo agreements.
• Liquidity Adjustment Facility was recommended by the Narasimhan Committee on Banking Reforms and was introduced by the RBI in 1998.
• There are two main components of Liquidity Adjustment Facility (LAF):
  • Repo Rate:
    • It is the rate at which the Reserve Bank of India (RBI) lends to other banks.
    • It is a part of the Liquidity Adjustment Facility (LAF) of the RBI.
    • The Repo rate borrowing is generally available at the overnight repo, 7 days, 14-day repo.
    • The commercial banks make a repurchase agreement with the RBI and sell the G-secs and buy back at a different rate on the agreed price.
    • The increased repo rate will discourage banks to borrow from the RBI and lending to the customers. This in turn will reduce the liquidity and demand in the market. It is part of the contractionary monetary policy.
    • On the other hand, decreased repo rate will encourage banks to borrow and lend to customers increasing the liquidity and demand in the market. This is a part of the Expansionary Monetary Policy.
    • As of December 2021 Monetary Policy Review, the Repo rate is set at 4.00%.
  • Reverse Repo Rate:
    • It is the rate at which the Reserve Bank of India (RBI) borrows from commercial banks.
    • It is a part of the Liquidity Adjustment Facility (LAF) of the RBI.
    • The Reverse Repo rate borrowing is generally available at 7 days, 14 days reverse repo rate.
    • The RBI makes a repurchase agreement with the commercial banks and sells the securities and buy them back at a different rate on the agreed price.
    • The increased reverse repo rate will encourage banks to lend to the RBI. This will reduce liquidity with the bank resulting in decreased lending activities and reduced demand in the market. It is part of the contractionary monetary policy.
    • On the other hand, decreased reverse repo rate will encourage banks to lend to customers rather than lending to RBI, therefore increasing the liquidity and demand in the market. This is a part of the Expansionary Monetary Policy.
    • As of December 2021 Monetary Policy Review, the Reverse Repo rate is set at 3.35%.

Standing Deposit Facility (MSF)

• Marginal Standing Facility (MSF) refers to the rate at which banks can borrow overnight funds from the RBI.
• This was introduced by the RBI in its credit policy of May 2011.
• The banks have to exchange the securities with the RBI to avail of the overnight credit through MSF.
• The maximum credit a bank can avail of through MSF is 3% of its total deposits (NDTL).
• The banks can use the securities under the SLR quota without paying a penalty as it is an emergency situation.
• This will shield the banks from the volatility of overnight inter-bank interest rates.
• Generally, the MSF is higher than the repo rate and MSF in December 2021 is 4.25%.

Long Term Repo Operation

• The Long-Term Reverse Repo Operation (LTRO) is a tool for facilitating the transmission of monetary policy and the flow of credit into the economy. This contributes to the injection of liquidity into the financial sector.
• The repo rate is used to provide funds through the LTRO. This means banks can take out one-year and three-year loans at the same one-day repo interest rate. However, compared to short-term (repo) loans, loans with a longer maturity time (such as one year and three years) normally have a higher interest rate.
• The LTRO scheme will be in addition to the Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF) operations, according to the RBI.
• In February 2020, the central bank conducted LTROs for one- and three-year tenors of appropriate amounts for up to a total sum of ₹ 1,00,000 crore at policy repo rates.
• The Core Banking Solution (E-KUBER) platform is used to perform LTROs. The operations would be carried out at a predetermined rate.
• The minimum bid amount will be Rs 1 crore, plus multiples of that amount. Individual bidders will not be limited in their maximum amount of bidding.

Market Stabilisation Scheme (MSS)

• The RBI's Market Stabilization Scheme (MSS) is a monetary policy tool for managing the economy's money supply.
• The securities issued are government bonds known as Market Stabilisation Bonds (MSBs). As a result, MSBs are the bonds issued under MSS.
• The government owns these securities, despite the fact that they were issued by the RBI.
• Government securities (bonds/treasury bills) are often sold or issued by the RBI, which serves as the government's banker.
• The government lends the RBI its bonds or securities (MSBs) to carry out the MSS. The RBI thus becomes a debtor to the government in the amount of the MSBs.
• However, the government cannot use the money raised during MSS and must be kept in a separate MSS account to pay for bonds at maturity.
• Interest is paid for the MSB’s by the government.
• During demonetisation, MSBs worth Rs 6 lakh crores were issued by the RBI to withdraw the excess liquidity.

Relationship between liquidity and quantitative tools

Significance of Quantitative tools

• Quantitative tools are linked to the quantity and volume of money, as the name implies.
• It is used to regulate the total amount of money and volume of bank credit in the economy.
• Quantitative tools are indirect instruments that are used to influence the amount of credit available in the economy.
• It affects the level of aggregate demand through the supply of money, cost of money and availability of credit.

Limitations of Quantitative tools

• Frequent changes in policy rates can cause speculations among the banks leading to poor transmission of monetary policy.
• Issues such as Non-Performing Assets has hindered credit creation in spite of Quantitative tools used to increase liquidity.
• The usage of quantitative tools alone can’t achieve the desired situation in an economy as there are many other parameters deciding money supply.

Conclusion

The Quantitative tools are used by the Reserve Bank of India in order to regulate the money supply in the economy and keep inflation at permissible levels in line with the Monetary Policy Framework Agreement needs.

FAQs

Question: What are quantitative tools of monetary policy?

Question: What is the Cash Reserve Ratio (CRR)?

Question: How do Open Market Operations (OMO) influence the economy?

Question: What is the Statutory Liquidity Ratio (SLR)?

Question: How does the Bank Rate differ from the Repo Rate?

MCQs

1. Which of the following is a quantitative tool of monetary policy?

a) Moral Suasion

b) Cash Reserve Ratio (CRR)

c) Credit Rationing

d) Public Debt

2. Open Market Operations (OMO) are used by the central bank to:

a) Regulate foreign exchange reserves

b) Control the money supply

c) Set banking sector interest rates

d) Promote government borrowing

3. The percentage of a bank's net demand and time liabilities that must be maintained in liquid assets like government securities is known as:

a) Cash Reserve Ratio (CRR)

b) Bank Rate

c) Statutory Liquidity Ratio (SLR)

d) Reverse Repo Rate

4. Which of the following is a direct impact of increasing the Cash Reserve Ratio (CRR)?

a) Increased lending capacity of banks

b) Reduced liquidity in the banking system

c) Higher inflation

d) Decreased repo rate

5. The Bank Rate is used by the central bank as a tool to:

a) Manage short-term liquidity

b) Provide long-term loans to commercial banks

c) Regulate foreign investment

d) Control fiscal deficit

GS Mains Questions and Model Answers

Q1: Critically examine the role of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) in maintaining financial stability in India.

Explanation: This question requires an examination of how the CRR and SLR help maintain financial stability. The answer should focus on how these tools control the money supply, regulate bank liquidity, and ensure financial discipline. It should also address how changes in these ratios can impact credit availability, inflation, and overall economic growth. The role of the Reserve Bank of India (RBI) in adjusting these ratios to stabilize the banking system and the broader economy should be highlighted.

Q2: Discuss the effectiveness of Open Market Operations (OMO) as a tool for monetary control in India.

Explanation: This question asks for a discussion of how effective Open Market Operations (OMO) are as a tool for controlling the money supply and managing economic conditions. The answer should explore how the RBI uses OMO to inject or absorb liquidity, its impact on inflation, interest rates, and exchange rates, and how it compares to other monetary tools like CRR and SLR. The answer should also consider any limitations or challenges in using OMO in the Indian context.

Q3: Analyze the impact of quantitative tools of monetary policy on economic growth and inflation in India.

Explanation: This question requires an analysis of how quantitative tools such as CRR, SLR, and OMO affect economic growth and inflation. The answer should discuss how these tools help control the money supply, influence credit availability, and regulate inflationary pressures. The impact of these measures on investment, consumer spending, and the overall economic environment should also be considered, along with the challenges faced by the central bank in balancing growth and inflation control.

Previous Year Questions on Quantitative Tools of Monetary Policy

1. UPSC CSE 2018

Q1: Discuss the role of quantitative tools in controlling inflation in India. 

Answer: Quantitative tools of monetary policy, such as the Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), and Open Market Operations (OMO), are critical for controlling inflation in India. By adjusting the CRR and SLR, the Reserve Bank of India (RBI) can control the liquidity available to banks for lending. When the RBI increases these ratios, banks are required to hold more funds in reserves, reducing the money available in the market, which helps curb inflation. Similarly, the RBI uses OMOs to sell government securities and absorb excess liquidity, reducing inflationary pressure. These tools ensure that the money supply aligns with the needs of the economy.

2. UPSC CSE 2019

Q2: Explain how Open Market Operations (OMO) help in managing the money supply in the economy.

Answer: Open Market Operations (OMO) are one of the primary tools used by the Reserve Bank of India to manage the money supply in the economy. Through OMO, the central bank buys or sells government securities in the open market. When the RBI buys securities, it injects liquidity into the banking system, increasing the money supply. Conversely, when the RBI sells securities, it absorbs liquidity, reducing the money supply. This mechanism helps manage inflation, stabilize the currency, and control interest rates. OMO is particularly effective during times of economic fluctuations, enabling the central bank to adjust liquidity as needed.