Test: Monetary Policy - UPSC MCQ

The correct answer is:

1. 1, 3 and 4 only

Explanation:

• Statement 1 is not correct: The Marginal Standing Facility (MSF) is not exactly the same as the repo rate; it is an emergency borrowing rate for banks above the repo rate. The MSF allows banks to borrow funds overnight from the RBI against government securities.

• Statement 2 is correct: The MSF is on the lines of the Liquidity Adjustment Facility (LAF) and is a part of it, designed to help banks manage overnight liquidity shortages.

• Statement 3 is not correct: While the MSF is a costlier route compared to the repo rate, it is considered a penal rate since it is higher than the repo rate to discourage excessive reliance on it.

• Statement 4 is not correct: Although banks typically use the MSF after exhausting other avenues for raising short-term funds, the nature of MSF being a penal rate and its higher cost is implied in the statement, making it misleading.

Therefore, statements 1, 3, and 4 are not correct.

Option 4, Neither 1 nor 2, is correct.

Cash Reserve Ratio (CRR) is a percentage of the total deposits of a bank that it is required to maintain with the central bank (in this case, the Reserve Bank of India or RBI). The main purpose of CRR is to ensure that banks have sufficient liquidity to meet the cash withdrawal and payment needs of their customers.

Statement 1 is incorrect because increasing the CRR tends to have the opposite effect of curbing deflation or low inflation. When the CRR is increased, banks are required to hold a larger proportion of their deposits with the RBI, which reduces the amount of money they have available for lending. This can lead to a contraction in the money supply and potentially contribute to deflation or low inflation.

Statement 2 is also incorrect because the RBI does not pay interest on the CRR that banks are required to maintain. The CRR is a percentage of the total deposits of a bank and is not a separate deposit or investment.

It is a 6 member body.3 members are nominated by the central government and 3 are from the RBI. It sets the policy rate to keep inflation within the band decided by the central government

Both statements are correct. SLR includes cash, gold and other government securities. Banks are eligible to earn interest on SLR .

In reverse repo RBI absorbs excess liquidity and acts a borrower. IN Repo rate transaction the RBI acts as a lender as it infuses more money in the system.

Open market operations are defined as the sale and purchase of government securities to control the money supply. They are usually done on an overnight basis

All of the above are used to maintain money supply in the economy. They are quantitative  measures for the same.

RBI deals with banks and other financial institutions for open market operations. RBI does not deal with the public directly.

CRR is the Cash reserve ratio. As the name suggests, it only deals with cash and no other form of monetary tool. It earns no interest

MSF is always above the repo rate as it is a penal rate. It is used for overnight lending by the RBI

Statement 1 is true: Yes, the Reserve Bank of India (RBI) has the sole authority to issue currency notes in India, excluding one rupee notes and coins, which are issued by the Ministry of Finance. Section 22 of the Reserve Bank of India Act gives the RBI this authority.

Statement 2 is False: The Reserve Bank of India (RBI) replaced the proportional reserve system with the minimum reserve system (MRS) in 1956 to make note issuance more flexible and to meet the economy's growing currency needs. 

Hence Statement 1 is correct.

The function that is not performed by the Reserve Bank of India (RBI) is:

• D: Collection and publication of data

The primary functions of RBI include:

• Banker to the government
• Regulation of foreign exchange
• Printing of currency

While RBI does collect and publish some data, it is not considered one of its primary functions. Other institutions like the National Statistical Office (NSO) focus mainly on data collection and publication.

- Statement 1: Incorrect. The Reserve Bank of India (RBI) provides advice on monetary policy matters, but it does not exclude agriculture and industrial finance from its purview. It plays a role in these sectors through various financial instruments and policies.
- Statement 2: Correct. The RBI is legally obliged to conduct the banking business of the central government and state governments, including Jammu & Kashmir, as per the RBI Act, 1934.
Thus, the correct answer is D: 2 only.

RBI is also responsible for regulating banks, directs their credit policies and provides advice to them.

The amount a bank needs to maintain in the form of cash, gold and other securities before giving credit is called SLR.