The instrument of monetary policy is tools/device which is used by the monetary authority in order to attain some predetermined objectives. There are two types of instruments –
Quantitative Instruments or General Tools: The Quantitative Instruments aka the General Tools of monetary policy (these tools are related to the quantity/volume of the money). They are designed to regulate or control the total volume of bank credit in the economy. These tools are indirect in nature and are employed for influencing the quantity of credit in the country. The quantitative measures of credit control are –
Bank Rate Policy (BR): The Bank Rate is the Official interest rate at which RBI re discounts the approved bills held by commercial banks. For controlling the credit, inflation and money supply, RBI will increase the Bank Rate.
Open Market Operations (OMO): OMO refers to direct sales and purchase of securities and bills in the open market by Reserve bank of India. The aim is to control volume of credit.
Cash Reserve Ratio (CRR): CRR refers to that portion of total deposits in commercial Bank which it has to keep with RBI as cash reserves.
Statutory Liquidity Ratio (SLR): SLR refers to that portion of deposits with the banks which it has to keep with itself as liquid assets (Gold, approved govt. securities etc.)
Qualitative Instruments: The Qualitative Instruments aka the Selective Tools of Monetary Policy. These tools are not directed towards the quality of credit or the use of the credit. They are used for discriminating between different uses of credit. This method can have influence over the lender and borrower of the credit. The selective tools of credit control comprises of following instruments –
Margin Requirements: This refers to difference between the securities offered and amount borrowed by the banks.
Consumer Credit Regulation: Under this method, consumer credit supply is regulated through hire-purchase and installment sale of consumer goods. Under this method the down payment, installment amount, loan duration, etc. is fixed in advance. This can help in checking the credit use and then inflation in a country.
Rationing of Credit: Central Bank fixes credit amount to be granted. Credit is rationed by limiting the amount available for each commercial bank. This method controls even bill rediscounting. For certain purpose, upper limit of credit can be fixed and banks are told to stick to this limit. This can help in lowering banks credit exposure to unwanted sectors.
Moral Suasion: It implies to pressure exerted by the RBI on the Indian banking system without any strict action for compliance of the rules. It is a suggestion to banks. It helps in restraining credit during inflationary periods. Commercial banks are informed about the expectations of the central bank through a monetary policy. Under moral suasion central banks can issue directives, guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes.
Direct Action: This step is taken by the RBI against banks that don’t fulfill conditions and requirements. RBI may refuse to re discount their papers or may give excess credits or charge a penal rate of interest over and above the Bank rate, for credit demanded beyond a limit
