Instruments of Monetary Control used by the Reserve Bank of India

The Monetary Policy Committee decides what the policy rate should be. The instruments are how that decision is made to bite. Some are quantitative, working on the volume and price of money available to the whole banking system. Others are qualitative, directing credit towards or away from particular uses. Each rests on a specific statutory power, and the examination question is almost always which provision supplies that power.

Figure 1: The principal quantitative instruments

1. The Cash Reserve Ratio

• Power: Section 42(1) of the RBI Act, 1934. Every scheduled bank must maintain with the Reserve Bank an average daily balance of not less than such percentage of its total demand and time liabilities in India as the Bank may, having regard to the needs of securing monetary stability, notify in the Official Gazette.
• No statutory limits: the fixed floor of three per cent was removed with effect from 1 April 2007. There is now no statutory minimum or maximum, and the ratio is entirely a matter for the Bank.
• Where it is held: with the Reserve Bank, in cash, and it earns no interest. The cost to the bank is the return it forgoes.
• Maintenance period: on an average daily basis over a fortnight, with a daily minimum prescribed by the Bank, which gives banks some flexibility within the fortnight. Following the Banking Laws (Amendment) Act, 2025, the fortnight runs from the 1st to the 15th and from the 16th to the last day of each month, with effect from 15 December 2025, in place of the earlier Saturday to second Friday cycle.
• Penalty (Section 42(3)): on a shortfall, penal interest at three per cent above the bank rate, rising to five per cent above the bank rate for continued default in the succeeding fortnight.
• Non-scheduled banks: keep their cash reserve under Section 18 of the Banking Regulation Act instead.
• Effect: raising the ratio withdraws lendable resources from the system; lowering it releases them. It acts on the volume of money rather than its price.

2. The Statutory Liquidity Ratio

• Power: Section 24 of the Banking Regulation Act, 1949. In addition to the cash reserve, every banking company must maintain in India assets of a value not less than such percentage, not exceeding forty per cent, of its total demand and time liabilities in India as the Reserve Bank may specify by notification.
• Form of the assets: cash, gold valued at a price not exceeding the current market price, and unencumbered approved securities, in the manner the Bank specifies.
• Where it is held: by the bank itself, not with the Reserve Bank, and it earns a return, since Government securities pay interest.
• Statutory ceiling only: the floor of twenty five per cent was removed in 2007, so only the forty per cent ceiling remains.
• Penalty: penal interest at three per cent above the bank rate on the shortfall, rising to five per cent above the bank rate if the default continues, with a fine on officers who are knowingly and wilfully party to a continuing default. The same calendar fortnight now governs SLR maintenance and returns as governs the cash reserve.
• Dual character: the ratio is a prudential requirement, ensuring that a bank holds liquid assets against its liabilities, and historically also a fiscal instrument, since it created a captive demand for Government securities.

3. Policy Rates and the Liquidity Adjustment Facility

• The bank rate (Section 49, RBI Act): the Bank must make public the standard rate at which it is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the Act. It is now aligned to the marginal standing facility rate and serves mainly as the reference for penal interest under Section 42(3) and Section 24.
• The repo rate: the rate at which the Bank lends to banks against Government securities under a repurchase agreement. It is the single policy rate that the Monetary Policy Committee sets.
• The standing deposit facility: introduced in April 2022 under Section 17(1A) of the RBI Act, inserted by the Finance Act, 2018, it allows banks to place surplus funds with the Bank without collateral and to earn interest on them. It is the floor of the corridor and has replaced the fixed reverse repo as the operative absorption rate.
• The marginal standing facility: allows banks to borrow overnight against securities, including by dipping into the statutory liquidity ratio holdings to a prescribed extent. It is the ceiling of the corridor and is ordinarily twenty five basis points above the repo rate.
• The corridor: the standing deposit facility rate, the repo rate and the marginal standing facility rate form a corridor within which the weighted average call rate, the operating target, is expected to move.
• Variable rate operations: the Bank conducts variable rate repo and reverse repo auctions of varying tenors to fine tune liquidity between policy meetings.

4. Open Market Operations

• Power: Section 17(8) of the RBI Act permits the Bank to purchase and sell securities of the Central or a State Government of any maturity.
• Effect: an outright purchase injects durable liquidity by paying rupees into the system; an outright sale withdraws it. Unlike repurchase operations, the effect is permanent rather than for a fixed term.
• Operation twist: the simultaneous purchase of long dated and sale of short dated securities, used to flatten the yield curve without changing the total liquidity in the system.
• Market Stabilisation Scheme: securities issued under a special arrangement with the Central Government to absorb liquidity arising from the Bank's foreign exchange operations, the proceeds being held in a separate account and not used for Government expenditure.
• Foreign exchange operations: purchases and sales of foreign currency under Section 17 and the Foreign Exchange Management Act, 1999 also inject or withdraw rupee liquidity, which is why exchange rate management and monetary management cannot be wholly separated.

5. Qualitative and Selective Instruments

Figure 2: Directing credit rather than controlling its volume

• Control of advances (Section 21, Banking Regulation Act): where the Reserve Bank is satisfied that it is necessary or expedient in the public interest, in the interest of depositors or of banking policy, it may determine the policy in relation to advances to be followed by banking companies, and may give directions as to the purposes for which advances may or may not be made, the margins to be maintained, the maximum amount of advances to any borrower, the maximum guarantees that may be given, and the rate of interest and other terms.
• Margin requirements: the difference between the value of the security and the amount lent. Raising the margin reduces how much can be borrowed against a given asset, and has been used to restrain speculative holding of commodities.
• Directed credit: the priority sector lending targets, currently forty per cent of adjusted net bank credit for domestic universal banks, with sub-targets for agriculture and weaker sections, and shortfalls deposited in funds such as the Rural Infrastructure Development Fund.
• Moral suasion: persuasion through letters, meetings and speeches, effective because the persuader is also the regulator.
• Direct action: the ultimate qualitative instrument, through directions under Section 35A enforceable by penalty under Sections 46 and 47A, and through restrictions on branch expansion and on access to the refinance window.

6. Transmission

An instrument is only as good as its transmission. A change in the repo rate must move the call money rate, then deposit and lending rates, then credit and demand, before it affects prices. Indian transmission was long impeded by administered lending rates. The prime lending rate, the benchmark prime lending rate, the base rate and the marginal cost of funds based lending rate each failed in turn, because banks retained discretion over the spread and were slow to pass on reductions. From 1 October 2019 the Bank required new floating rate loans to individuals and to micro and small enterprises to be linked to an external benchmark, usually the repo rate or a treasury bill yield, which has made transmission faster and more symmetrical.

• Structural impediments: a large share of fixed rate small savings instruments competing for deposits, stressed assets that make banks reluctant to lend, and fiscal dominance when Government borrowing is heavy.
• Lags: monetary policy works with long and variable lags, ordinarily estimated at three to four quarters, which is why the Committee acts on forecast inflation rather than current inflation.

7. Quick Revision

8. Frequently Asked Questions

What is the difference between CRR and SLR?

The cash reserve ratio arises under Section 42(1) of the RBI Act, 1934, is maintained in cash with the Reserve Bank, and earns no interest. The statutory liquidity ratio arises under Section 24 of the Banking Regulation Act, 1949, is maintained by the bank itself in cash, gold or unencumbered approved securities, and earns a return. The first is primarily a monetary instrument, the second primarily a prudential one.

Is there a maximum limit on the cash reserve ratio?

No. The statutory floor of three per cent and the ceiling of twenty per cent were both removed with effect from 1 April 2007. The Reserve Bank fixes the percentage by notification in the Official Gazette, having regard to the needs of securing monetary stability. By contrast, the statutory liquidity ratio may not exceed forty per cent.

What is the repo rate?

The rate at which the Reserve Bank lends to banks against the collateral of Government securities under a repurchase agreement. It is the single policy rate set by the Monetary Policy Committee, and the whole corridor of the liquidity adjustment facility is built around it.

What is selective credit control?

The use of Section 21 of the Banking Regulation Act to direct credit towards or away from particular purposes rather than to control its total volume. The Reserve Bank may prescribe the purposes for which advances may be made, the margins, the maximum amount to any borrower, the maximum guarantees, and the rate of interest and other terms.

Why does a change in the repo rate not immediately change loan rates?

Because transmission runs through several stages and each can absorb the change. Banks fund themselves partly through fixed rate deposits that reprice slowly, compete with small savings instruments whose rates are administered, and may widen spreads when asset quality is poor. The external benchmark requirement of 1 October 2019 was introduced precisely to shorten this chain for retail and small business loans.

Why does the cash reserve ratio have no statutory floor or ceiling?

Because the limits were removed deliberately, to free the instrument for monetary policy. The Reserve Bank of India Act, 1934 formerly fixed a floor of three per cent and a ceiling of twenty per cent, which meant that in conditions of very large capital inflow or very severe contraction the Reserve Bank could run out of instrument before it ran out of problem. The amendment that took effect from 1 April 2007 removed both, so the ratio may now be fixed at any rate the Reserve Bank considers appropriate. The statutory liquidity ratio went the other way for a different reason: its ceiling of forty per cent survives, because that ratio operates as a pre-emption of bank resources for government securities and an unlimited power would allow the banking system to be conscripted without limit.

9. Related Topics and Provisions

• Monetary policy and the Monetary Policy Committee
• The Reserve Bank as banker to the Government and to banks
• Priority sector lending
• Inspection and the power to issue directions (Sections 35 and 35A)
• Penalties under the Banking Regulation Act (Sections 46 and 47A)