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L1/P2: Banking-Monetary Policy Introduction, CRR, SLR, OMO

Mrunal Patel・2 minutes read

Money was invented to solve the barter system's flaw of double coincidence of wants, evolving from terracotta coins to modern-day paper currency. Financial intermediaries facilitate the circular flow of money between households and businesses, with monetary policies like CRR and SLR controlling inflation and deflation.

Insights

  • Money was invented to solve the issue of the double coincidence of wants in trading, leading to the evolution of various forms of currency throughout history, such as terracotta coins, metallic coins, and paper currency.
  • Proper management of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) is crucial for financial stability, ensuring banks can meet withdrawal demands while complying with regulations, preventing bank runs, and maintaining liquidity.

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Recent questions

  • What was the flaw of the barter system?

    The flaw of the barter system was the double coincidence of wants, requiring both parties to have desired items for trade.

  • How did money evolve over time?

    Money evolved from terracotta coins to metallic coins and paper currency.

  • What is the role of financial intermediaries?

    Financial intermediaries facilitate the flow of money between households and businesses.

  • How does the Central Bank combat inflation?

    The Central Bank combats inflation through a tight money policy.

  • What are the key components of monetary policy?

    The key components of monetary policy include Reserve Ratio (CRR and SLR) and Open Market Operations.

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Summary

00:00

Evolution of Money: From Barter to Banking

  • Before the invention of money, people used the barter system to trade goods.
  • The barter system had a flaw known as the double coincidence of wants, requiring both parties to have desired items for trade.
  • Money was invented to solve the issue of the double coincidence of wants in trading.
  • The evolution of money started with terracotta coins in the Harappan culture, leading to metallic coins in the medieval era and paper currency in modern times.
  • The modern money system involves a circular flow of income between households and businesses.
  • Financial intermediaries facilitate the flow of money between households and businesses.
  • Tight money policy is implemented by the Central Bank to reduce money supply and fight inflation.
  • Deflation, the opposite of inflation, can have negative effects on the economy.
  • To combat deflation, the Central Bank can increase money supply through a cheap money policy.
  • Monetary policy tools like Reserve Ratio (CRR and SLR) and Open Market Operations are used to implement monetary policies.

12:51

Bank Stability Through CRR and SLR Compliance

  • Opening a savings account in Kotak Yes Bank offers an interest rate of 6%, while a fixed deposit yields 9% or slightly lower.
  • Interest paid by the bank to depositors must be recovered by lending money at rates higher than those offered to depositors.
  • To avoid a crisis, it's crucial not to lend out all incoming funds but to maintain an emergency backup, typically around 26% of total funds.
  • Demand liability includes current and savings accounts, allowing customers to withdraw funds at any time, while time liability includes fixed deposits and recurring deposits.
  • Net Demand and Time Liabilities (NDTL) are calculated by subtracting withdrawals from total funds, with a portion set aside for Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR).
  • CRR requires banks to keep a portion of funds aside without the ability to lend or invest, while SLR mandates investment in liquid assets like cash, gold, or RBI-approved securities.
  • Maintaining CRR and SLR ensures liquidity and compliance with regulations, preventing bank runs and financial instability.
  • Banks can invest in gold, cash, or RBI-approved securities to meet SLR requirements, potentially earning profits through wise investments.
  • Weekly calculations of NDTL determine the amount to be kept in CRR and SLR, with penalties for non-compliance.
  • Proper management of CRR and SLR is essential for financial stability, ensuring banks can meet withdrawal demands while adhering to regulatory standards.

25:17

"Combatting Inflation with Tight Money Policy"

  • Fortnite is calculated from Friday and kept for one cycle.
  • NDTL, SLR, and CRR are discussed, leading to fighting inflation using them.
  • A hypothetical scenario is presented with two banks having Rs 2 crores, no CRR or SLR, and giving loans at Rs 10 interest.
  • The banks end up with Rs 20 lakhs after lending Rs 10 lakhs.
  • To combat inflation, money supply needs to be reduced through tight money policy.
  • Decreasing money supply makes money precious, leading banks to increase interest rates.
  • Rising interest rates reduce demand, impacting markets like automobile and real estate.
  • Inflation is fought with tight money policy, while deflation is countered with easy money policy.
  • Implementing CRR and SLR adjustments can control inflation and deflation.
  • Raghuram Rajan changed the policy to update every 60 days instead of 45, affecting monetary policy reviews.

38:12

Rajan Bhai Reduces SLR to Boost Lending

  • SLR was reduced from 23 to 22 by Rajan Bhai, while CRR remained at 4.
  • Rajan Bhai's decision to reduce SLR was to provide more funds for lending to productive sectors.
  • Banks typically invest SLR funds in government securities to finance government schemes and subsidies.
  • Government's reduced expenses led to lesser need for funds from banks, prompting SLR reduction.
  • Open Market Operations involve buying and selling government securities to control money supply.
  • To fight inflation, money supply needs to be reduced through open market operations.
  • Selling securities to the public increases money supply, while buying reduces it.
  • Understanding open market operations is crucial for MCQs and economic concepts.
  • Elimination method helps in quickly and accurately answering complex economic questions.
  • When in doubt during exams, it's advisable to skip questions rather than guessing.
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