Monetary Policy Tools in India: Monetary Policy Committee, Monetary Policy Tools, Types, & UPSC PYQs

Monetary Policy refers to the policy of the Reserve Bank of India to regulate the supply of money, credit, and interest rates in the economy to achieve objectives such as price stability, economic growth, and financial stability. The Qualitative tools of monetary policy determine the direction of the money supply, whereas the Quantitative Tools control the volume of the money supply. 

This topic of ‘Monetary Policy in India’ is important from the perspective of the UPSC Civil Services Examination, particularly under General Studies Paper III (Indian Economy), Banking, Inflation, Financial Markets, and Economic Development. 

Monetary Policy

• Monetary policy is the process through which the Monetary Authority of India (RBI) controls money creation and money supply. The primary objective of monetary policy is to maintain price stability while also supporting economic growth.

Monetary Policy Tools:

The Monetary Policy tools are classified into quantitative and qualitative.

Quantitative Tools:

• Repo Rate: This is the rate at which the RBI provides overnight liquidity to banks, up to a certain percentage of their Net Demand and Time Liabilities (NDTL), in exchange for government securities as collateral. 

• The current repo rate is 5.25% (as of June 2026).

• Marginal Standing Facility (MSF): This is the rate at which banks can borrow additional funds overnight by dipping up to 2% into their Statutory Liquidity Ratio (SLR) reserves, using government securities as collateral. Under MSF, banks can borrow funds up to one per cent of their net demand and time liabilities (NDTL).

• MSF Rate = Repo Rate + 0.25% = 5.50% (as of June 2026).

• Bank Rate: Currently, the bank rate is not used for lending but is applied as a penal rate for defaulting banks.

• Bank Rate = Repo Rate + 0.25% = 5.50% (as of June 2026).

• Reverse Repo Rate: Although it was previously used for banks to deposit surplus funds with the RBI, it has now become practically redundant. Earlier, when banks deposited money under reverse repo, the RBI had to keep government securities as collateral with banks.

• Standing Deposit Facility (SDF): This is the rate at which banks deposit excess cash with the RBI. Unlike the Reverse Repo Rate, the RBI does not need to provide collateral to banks under this facility. 

• SDF = Repo Rate - 0.25% = 5.00% (as of June 2026).

• Liquidity Adjustment Facility (LAF): This is the framework through which the RBI injects or absorbs liquidity into/from the banking system. It includes overnight and long-term repo, reverse repo auctions, SDF, and MSF.

• Reserve Requirements: Reserve requirements are compulsory measures for banks to maintain financial stability by ensuring an adequate money supply in the economy.

• Cash Reserve Ratio (CRR): The CRR is the percentage of Net Demand and Time Liabilities (NDTL) that banks are required to maintain with the Reserve Bank of India (RBI) at any given time. Banks deposit this amount in cash with the RBI and do not receive any interest on it. The current CRR rate is 3.00 % (as of June 2026).

• Statutory Liquidity Ratio (SLR): The SLR requires banks to maintain a specified percentage of their deposits in the form of cash, gold, or government securities. If a bank deposits more than the required CRR with the RBI, the excess amount is counted as SLR, and banks earn interest on that portion. The current SLR rate is 18.00 % (as of June 2026).

Qualitative Tools of Monetary Policy

• Rationing of Credit: Under this measure, the RBI rations credit to be given by the banks in accordance with the priorities of the economy and as per the importance of various sectors of the economy. For Example: RBI has directed the bank should give 40% of their total credit at any given point in time earmarked for the priority sector of India. 

• Variation in Margin Requirements: It means that the RBI may instruct banks from time to time to raise the margin on loans for essential commodities so as to prevent hoarding, speculation, and black marketing. 

• Moral Suasion: It is a combination of persuasion and pressure, under which a central bank is always in a position to use it on banks in general and particularly on those banks that do not follow the directions of the RBI. 

• This is exercised through discussions, letters, speeches, hints, emails, messages, meetings, etc. Moral suasion is a request by the RBI to commercial banks to take specific measures as per the economy's trends. 

• For example, the RBI may direct banks not to give out certain loans. It includes psychological means and informal means of selective credit control.

• Direct Action: Under direct action, the RBI may take punitive actions against those banks that do not follow the moral advice of the RBI and act against the RBI and depositors' interests. 

• It may be in terms of penalty, dropping the refinancing facilities, temporary suspension of bank operations, and even extreme steps of placing a moratorium on the banks and ultimately canceling the bank's license to operate.

Types of Monetary Policy

Monetary Policy can be classified into: Expansionary and Contractionary

Expansionary Policy

• It is also known as the Easy Money Policy, Dovish Policy, or Accommodative Policy, and is used to increase the money supply in the economy. It is implemented to boost economic growth, reduce unemployment, and encourage borrowing and investment.

• The Reserve Bank of India (RBI) achieves this by lowering the Repo Rate, which makes borrowing cheaper for banks, reducing the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) to allow banks to lend more, and purchasing government securities through Open Market Operations (OMO) to inject liquidity into the economy.

Contractionary Policy

• On the other hand, Contractionary Monetary Policy is used to reduce the excess money supply to control inflation. It aims to prevent the economy from overheating and ensure financial stability.

• The RBI implements this by increasing the Repo Rate, making loans costlier, raising the CRR and SLR, which reduces the funds available for lending, and selling government securities through OMO to absorb excess liquidity from the market. This type of policy is typically used when inflation is high and poses a risk to economic stability.

UPSC Previous Year Questions and Practice Questions

Q1. If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do? (2020) 

1. Cut and optimise the Statutory Liquidity Ratio 

2. Increase the Marginal Standing Facility Rate 

3. Cut the Bank Rate and Repo Rate. 

Select the correct answer using the code given below: 

1. 1 and 2 only 

2. 2 only 

3. 1 and 3 only 

4. 1, 2 and 3 

Answer: B

Statement 1 is incorrect: Reducing SLR leaves more liquidity with banks, which in turn can fuel growth and demand in the economy. 

Statement 2 is correct: With the increase of the MSF rate, the cost of borrowing increases for banks, resulting in reduced available resources to lend. 

Statement 3 is incorrect: Under expansionary monetary policy, the RBI reduces the repo rate and bank rate to increase liquidity in the banking sector. 

Q2. Which of the following statements is/are correct regarding the ‘Monetary Policy Committee (MPC)? (2017) 

1. It decides the RBI’s benchmark interest rates. 

2. It is a 12-member body, including the Governor of the RBI, and is reconstituted every year. 

3. It functions under the chairmanship of the Union Finance Minister. 

Select the correct answer using the code given below:

1. 1 only 

2. 1 and 2 only 

3. 3 only 

4. 2 and 3 only 

Answer: A

Statement 1 is correct: MPC determines the policy interest rate, which is required to achieve the inflation target. 

Statement 2 is incorrect: As per the provisions of the RBI Act, the Monetary Policy Committee is a six-member body of which three Members will be from the RBI and the other three Members of the MPC will be appointed by the Central Government. 

Statement 3 is incorrect: The Governor of the Reserve Bank of India is the ex officio Chairperson of the MPC. 

Q3. When the Reserve Bank of India reduces the Statutory Liquidity Ratio by 50 basis points, which of the following is likely to happen? (2015) 

1. India’s GDP growth rate increases drastically 

2. Foreign Institutional Investors may bring more capital into our country 

3. Scheduled Commercial Banks may cut their lending rates 

4. It may drastically reduce the liquidity in the banking system 

Answer: C

The Statutory Liquidity Ratio (SLR) cut by the RBI is likely to give more room for banks to cut rates. Scheduled Commercial Banks may cut their lending rates. The portion of deposits that banks must hold in the form of gold or government securities before extending credit to consumers is known as the SLR. 

Q4. The terms ‘Marginal Standing Facility Rate’ and ‘Net Demand and Time Liabilities’, sometimes appearing in the news, are used in relation to: (2014) 

1. Banking operations 

2. Communications networking 

3. Military strategies 

4. Supply and demand of agricultural products 

Answer: A

Marginal standing facility (MSF) is a window for banks to borrow from the Reserve Bank of India in an emergency when interbank liquidity dries up completely. z The difference between a bank’s total demand and time liabilities (deposits) of a bank and its deposits in the form of assets held by another bank is represented by the term “Net Demand and Time Liabilities”.