Since the IE & IFS have been added to the JAIIB 2024 syllabus and pattern, Monetary policy is an important topic to understand.

Monetary policy is an integral part of the Indian macroeconomy. Central banks take a course of action to achieve macroeconomic objectives such as stability of the economy, inflation control and employment.

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One cannot choose to ignore this topic as it’s the most crucial topic of Module B of the Indian economy which is Economic concepts related to banking.

Let’s dig in further to understand the concepts of money and the tools of monetary policy.


Monetary policy is the Central Bank’s tool by which it controls the following to achieve national economic growth and stability.

  • Money supply in the market 
  • Availability of money
  • Rate of Interest which can be said to be the cost of money

RBI makes monetary policy statements bi-monthly basis.

Based on these objectives RBI can craft the following kind of monetary policy:

  • Expansionary policy (Increase total supply of money)
  • Contractionary policy (Decrease total supply of money)


Tools of monetary policy | IMPORTANT TOPIC

To regulate the cost, use and availability of money and credit following instruments are used:

Bank rate

The Bank rate is the interest rate paid by banks to the RBI, upon the long-term borrowing received by them. It is a discount rate at which RBI grants long-term loans to commercial banks and the loan can be raised without pledging securitization. It adjusts automatically when and when the MSF rate changes, roughly in line with changes in policy repo rates, and is in line with the MSF (Marginal Standing Facility) rate. Despite this, the role of the Bank rate has been limited due to the interest rate structure not axiomatically related to the Bank rate, commercial banks are given access to specific refinancing options and are not required to rediscount their eligible securities with the RBI at the bank rate, and various segments of the money market are unaffected by the bank rate.

Marginal standing facility 

MSF is a facility for scheduled commercial banks to borrow overnight from the RBI, providing a safety valve against liquidity shocks.

MSF rate is a rate at which commercial banks borrow funds overnight from the RBI and the loan is given against security within the limits of SLR and up to a particular percentage of NDTL.

The current SLR portfolio limit is 2% of their NDTL outstanding at end of the second preceding fortnight and the penal rate of Interest is 25 basis points above the repo rate. 

So, MSF is a facility at which, scheduled commercial banks can borrow additional amounts of overnight money from RBI. This provides a safety valve against any unprecedented liquidity shocks to the banking system. Short-term money market interest rates are determined by the reverse repo and MSF rates.

Cash reserve ratio

The fractional reserve banking system requires banks to keep a fraction of their deposit liabilities in liquid cash with the RBI, as a share of their net demand and time liabilities (NDTL). The CRR may be set by the RBI at any value.

Let’s understand how is CRR used as a tool of credit control.

When the money supply increases and causes inflation to rise, RBI increases the Cash reserve ratio which eventually reduced the cash funds available to the banks to make loans hence money supply is reduced and so is inflation.

Statutory liquidity ratio

The statutory liquidity ratio (SLR) is the amount all banks have to maintain in form of cash/gold/approved securities. It is determined as the percentage of total demand and time liabilities. SLR is maintained to control the expansion of the Bank credit, as changes in SLR can influence the expansion or contraction of Bank credit. RBI compels commercial banks to invest in the government securities like government bonds to ensure the solvency of a bank.

Standing Deposit Facility (SDF)

The Standing Deposit Facility (SDF) is a tool used by the RBI to absorb excess cash from the economy without giving it to the lenders. It absorbs liquidity without any collateral and allows participants to place deposits with the RBI overnight. SLR is the number of funds that a bank has to maintain in form of liquid assets (cash, gold) unlike the CRR which is an amount of money that banks are obliged to keep with the RBI. SLR controls the Bank’s leverage for credit expansion and ensures the solvency of the commercial bank. Banks commonly earn interest as the return on the funds kept as SLR which cannot be witnessed in the case of CRR.

Base rate

The Base Rate came into effect on July 1, 2010, replacing Benchmark Prime Lending Rate (BPLR).

It comprises all aspects of the interest rate that apply to all types of borrowers.

All kinds of loans are subject to be priced at the Base rate and it’s applicable for all new loans and old ones that are renewed. 

The reason banks aren’t allowed to resort to any lending below the Base year is that it’s the lowest rate for all the loans.

The lending rate based on the marginal cost of funds (MCLR)

MCLR is an instrument used by the RBI to set the lending rate. It is composed of a marginal cost of funds (MCLR), negative carry on the CRR (CRR balances being negligible), operating costs (all operating costs related to providing the loan product), and tenor premium (loan commitments with longer tenor). RBI updates this rate when there is a significant shift in the nation’s economic activities. Banks are prohibited from making loans at a rate lower than the MCLR.

External benchmark-based lending rate (EBLR)

EBLR was introduced to transfer the benefits of the rate of Interest to borrowers, as Base rate/MCLR has not delivered effective transmission of monetary policy. RBI ordered banks to establish a uniform external benchmark within a loan category, which can only be altered once in 3 years unless the borrower’s credit assessment changes significantly and as agreed with the loan contract.

Market stabilisation scheme (MSS)

RBI’s monetary policy intervention is to absorb liquidity from the market by selling government securities. For example, in 2004, Foreign Institutional investors brought dollars to purchase Indian stocks, leading to an oversupply of US dollars in the Indian market. In 2016, massive deposits were made into the banking system following the demonetisation.

Repo rate

The Repurchase rate is the rate at which RBI lends money to commercial banks to maintain liquidity and control inflation. It is determined by the maturity of the underlying securities, the period of the repo, and the pricing. Bank lending rates are Repo rate dependent. Repo rates can be held in custody, classic, bond borrowing, and tripartite repos.

Tri-party Repo (TREPS)

It’s a three-party repo arrangement in which the third entity (other than the borrower and lender) acts as an intermediary where the mediator acts as a go-between for the two parties to the repo to assist services including choosing collateral, paying for it, settling it, and managing possession and the transaction’s life.

Term repo

To induce liquidity over a period that is longer than overnight RBI introduced a Term repo of different tenors (7/14/28). It aimed to create an inter-banking money market to set market-based benchmarks, for the pricing of loans and deposits.

Special long-term repo operations (SLTRO)

To help micro small and medium industries and unorganised sect or entities during a pandemic, RBI introduced SLTRO for small finance banks to be deployed for fresh lending up to Rs. 10 Lakh per borrower. 

Reverse repo

It’s the rate of interest at which the bank keeps its liquidity with the Central Bank. When the money flow increases in the market RBI borrows the money from banks at High interest (so that banks prefer to place their liquidity with the Central bank). 

Repo rate signifies the rate at which liquidity is injected into the banking system.

The reverse repo rate signifies the rate at which the liquidity is absorbed from the banks.

Variable rate reverse repo (VRRR)

The VRRR is typically implemented to decrease the money flow by removing existing currency from the system.

By moving the excess liquidity from the fixed-rate overnight reverse repo window to VRRR auctions with longer maturities, the central bank attempts to rebalance the system.

Open market operations

Here government bonds are sold or bought in the secondary market by the Central Bank. 

By absorbing bonds, it raised the bond yield and influx the money in the market.

The central bank has the power to influence the money supply and short-term interest rates by selling bonds and sucking the money out of the market.

RBI deploys the following 2 kinds of OMOs:

  • Permanent: Outright purchase (Involves selling or buying of govt securities)
  • Repurchase Agreement: Short-term (subject to repurchase)

Refinance facilities

Sector-specific objectives are aimed with the help of provisions of liquidity at a cost linked to the policy repo rate. 

Liquidity adjustment facility (LAF)

Banking sector reforms consist of two parts: a reverses repo and a repo (repurchase agreement). The repo rate is the price at which banks borrow money from the RBI. Banks can store their excess cash with the RBI by using the reverse repo mechanism and the reverse repo rate. By altering the money supply, the RBI can control inflation in the economy.


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