This MCQ module is based on: Monetary Policy, MPC, Demonetisation & Exercises
TOPIC 8 OF 17
Monetary Policy, MPC, Demonetisation & Exercises
🎓 Class 12
Economics
CBSE
Theory
Chapter 3 — Money and Banking
⏱ ~28 min
🌐 Language: [gtranslate]
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Monetary Policy Tools of the RBI & Money-Banking Exercises
When the RBI Governor speaks, markets listen. A 25-basis-point change in the repo rate can move the entire yield curve, alter home loan EMIs for crores of families, and reshape India's growth trajectory for the next year. Part 3 unpacks the toolkit the RBI uses to steer money supply — the quantitative instruments (CRR, SLR, repo rate, OMO, MSF) and the qualitative ones (margin requirements, moral suasion, credit allocation). We meet the Monetary Policy Committee that decides repo rates since 2016, examine demonetisation of November 2016 and the UPI revolution, and finally walk through every NCERT exercise question with full model answers — plus a complete summary and key-terms glossary.
3.7 The RBI's Monetary Policy Toolkit
The RBI controls money supply in the economy through two broad classes of tools: quantitative (which act on the volume of credit) and qualitative (which act on the type of credit). Quantitative tools change the cost or availability of reserves uniformly; qualitative tools nudge banks selectively into or out of particular sectors.
Monetary Policy: Quantitative vs Qualitative Tools
Bloom: L2 Understand3.7.1 Quantitative Tools — The Big Five
① Cash Reserve Ratio (CRR). Already met in Part 2. Currently 4.5% of NDTL (Net Demand and Time Liabilities). Earns no interest for the bank. A rise in CRR contracts money supply; a cut expands it.
② Statutory Liquidity Ratio (SLR). The percentage of NDTL that banks must hold themselves in approved liquid assets — cash, gold, government and other approved securities. Currently 18%. Unlike CRR, SLR balances earn interest. SLR ensures liquidity AND helps the government finance its borrowing (G-Secs are the dominant SLR-eligible asset).
③ Repo Rate. The rate at which the RBI lends short-term funds to commercial banks against the collateral of government securities, under a repurchase agreement (repo). It is now the policy rate — the single most important interest rate in India. A rise in repo makes borrowing from RBI costlier → lending rates rise → demand for credit falls → money supply contracts. The Reserve Bank conducts repo and reverse-repo operations at various maturities — overnight, 7-day, 14-day. Repos have become the main tool of monetary policy.
④ Reverse Repo Rate. The rate at which the RBI borrows from commercial banks (or, equivalently, banks park their surplus funds with the RBI). When banks have excess liquidity, they prefer to park it with the RBI at the reverse repo rate. A higher reverse repo rate absorbs liquidity from the system. The current floor of the policy corridor is the Standing Deposit Facility (SDF) rate, set 25 bps below repo.
⑤ Open Market Operations (OMO). The RBI buys or sells government securities in the open market. Buying G-Secs injects liquidity (RBI pays for them with a cheque, expanding bank reserves); selling G-Secs absorbs liquidity. There are two flavours: outright OMOs (permanent) and repo OMOs (with promise of reversal). Outright OMOs are now rare; repo operations dominate.
⑥ Bank Rate. The rate at which the RBI is willing to rediscount first-class bills of exchange and other approved commercial paper. It is a long-term lending rate. Once the principal monetary tool, it has been overshadowed by the repo rate. Currently aligned with the MSF rate (repo + 25 bps).
⑦ Marginal Standing Facility (MSF). Introduced in 2011, MSF lets banks borrow overnight from the RBI, against G-Secs, at a rate above the repo rate (currently repo + 25 bps). MSF is the upper end of the LAF (Liquidity Adjustment Facility) corridor.
| Tool | Current Value | Effect of an Increase |
|---|---|---|
| CRR | 4.5% | Money supply ↓ |
| SLR | 18.0% | Money supply ↓ |
| Repo Rate | 6.50% (under review by MPC) | Lending rates ↑ ; Money supply ↓ |
| SDF (Reverse Repo floor) | 6.25% | Liquidity absorbed ↑ |
| MSF | 6.75% | Emergency borrowing costlier |
| Bank Rate | 6.75% (= MSF) | Long-term borrowing costlier |
3.7.2 Qualitative Tools
Margin Requirements. When you borrow against collateral (gold, shares, real estate), the bank lends only a part of the collateral's market value. The difference is the margin. A higher margin means the borrower must put in more own funds → loans contract.
Moral Suasion. The RBI uses persuasion, advisories, and informal meetings to influence commercial bank behaviour. Not legally binding but quite effective in India because of the RBI's authority. During COVID-19, for example, RBI used moral suasion to encourage banks to grant loan moratoriums.
Direct Credit Allocation. Through Priority Sector Lending (PSL) norms, the RBI requires banks to allocate at least 40% of net bank credit to agriculture, micro and small enterprises, weaker sections, and education and housing for the poor. This is a sector-specific qualitative directive.
3.7.3 The Monetary Policy Committee (MPC)
Since the RBI Act amendment of 2016, the policy repo rate is decided not unilaterally by the RBI Governor but by a six-member Monetary Policy Committee (MPC)?. Three members are RBI insiders (Governor, Deputy Governor in charge of monetary policy, and one Executive Director); the other three are external economists appointed by the Government of India for a 4-year term.
📚 The MPC's Statutory Mandate
The MPC must keep the year-on-year Consumer Price Index (CPI) inflation at 4 per cent ± 2 per cent (i.e., 2% to 6% band) over the medium term. The current target was set in 2016 and re-confirmed in 2021 for a 5-year period. The MPC meets bi-monthly (at least 4 times a year, usually 6) and the Governor has the casting vote in case of a tie.
3.7.4 The Big Macro Events — Demonetisation and UPI
Demonetisation, 8 November 2016. On the night of 8 November 2016, the Government of India declared that ₹500 and ₹1,000 currency notes would no longer be legal tender. The aim was to fight black money, terror financing, fake currency and corruption. New ₹500 and ₹2,000 notes were introduced. The public was asked to deposit old notes in their bank accounts till 31 December 2016 (without declaration) and till 31 March 2017 with the RBI (with declaration). To avoid a complete cash crunch, exchange of ₹4,000 of old notes per person per day was permitted; old notes were accepted at petrol pumps, government hospitals and for paying government dues till 12 December 2016.
The move drew both praise and criticism. There were long queues at banks and ATMs and the cash crunch slowed economic activity. On the positive side, it brought a large number of people into the tax ambit, channelled informal savings into the formal financial system, gave banks more resources for lending at lower rates, and accelerated India's shift from cash to electronic payments. Subsequently, in May 2023, the RBI also announced the withdrawal of ₹2,000 notes — they remain legal tender but are being progressively phased out.
💡 Demonetisation in Numbers
About 86% of India's currency-in-circulation by value was demonetised overnight in November 2016 (₹500 + ₹1,000 notes = ~₹15.4 lakh crore). Within a few weeks, most of this was redeposited in banks — over 99% by the RBI's later count. The promised "extinction of black money" did not materialise as expected, but tax filings rose sharply: the number of income-tax return filers grew from 4.0 crore in 2015–16 to 6.0+ crore by 2018–19.
UPI and Digital Banking. The Unified Payments Interface (UPI) was launched by the National Payments Corporation of India (NPCI) in April 2016. UPI lets a user instantly transfer money from any bank account to any other using just a Virtual Payment Address (VPA) or QR code, 24×7, free of cost for individuals. By 2024–25, UPI was settling roughly 17,000 crore transactions a year worth ₹260+ lakh crore — bigger than India's GDP. Beyond UPI, the digital push includes Aadhaar-Enabled Payment System (AePS), Bharat Bill Payment System (BBPS), and the digital rupee (CBDC) piloted by the RBI from December 2022.
India's Repo Rate, 2010–2024 (%)
Figure 3.2: The MPC has used the repo rate as the dominant monetary tool, cutting through the COVID period to 4.0% and then hiking to 6.5% to fight post-pandemic inflation. Source: RBI press releases.
India: CPI Inflation vs Repo Rate, 2014–2024 (%)
Figure 3.3: The MPC's job is to keep CPI inflation in the 2–6% band centred on 4%. After CPI breached 7% in mid-2022, the MPC tightened repo by 250 bps. Source: RBI; MoSPI.
LET'S EXPLORE — Quantitative or Qualitative?
Bloom: L3 Apply
For each RBI action, classify the tool used as Quantitative or Qualitative — and predict its effect on money supply.
- RBI cuts the repo rate by 25 basis points.
- RBI advises banks to be cautious in lending to real estate.
- RBI conducts an OMO purchase of ₹40,000 crore G-Secs.
- RBI raises the margin requirement on gold loans from 25% to 35%.
- RBI increases the SLR from 18% to 19%.
✅ Answer Key
(1) Quantitative — borrowing from RBI cheaper; lending rates fall; money supply expands. (2) Qualitative (moral suasion); selectively reduces real-estate credit; modest contraction in that sector. (3) Quantitative; OMO purchase injects liquidity; money supply expands. (4) Qualitative (margin requirement); borrowers must bring more own funds; gold-loan demand falls. (5) Quantitative; banks must keep more in liquid assets; lending capacity falls; money supply contracts.
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Competency-Based Questions — Part 3
Case Study: India's CPI inflation has spiked to 7.4% in June 2022, breaching the MPC's upper tolerance band of 6%. The MPC at its August 2022 meeting decides to raise the repo rate by 50 bps from 4.90% to 5.40%, while keeping CRR unchanged at 4.5%. The Governor explains this is the third consecutive rate hike to anchor inflation expectations.
Q1. The MPC's statutory mandate for CPI inflation in India is:
L1 RememberAnswer: (B) — Under the RBI Act amendment of 2016, the MPC must keep CPI inflation at 4% ± 2% (i.e., 2–6%) over the medium term. The target was renewed for another 5-year period in March 2021.
Q2. The repo rate hike of 50 bps is most likely to lead to:
L4 AnalyseAnswer: (C) — Higher repo rate raises the cost at which banks borrow from the RBI; banks pass on this to borrowers as higher lending rates; credit demand falls; aggregate demand cools; inflation eventually moderates. Effects work with a lag of several quarters — option (D) is unrealistic.
Q3. The MPC has six members. List their composition. If the vote is tied 3–3, who has the casting vote? Explain why this committee structure was created in 2016.
L5 EvaluateModel Answer: Composition — three RBI internal members (Governor; Deputy Governor in charge of monetary policy; one Executive Director nominated by the Central Board) and three external members appointed by the Government of India for a 4-year term. Casting vote: the RBI Governor. Why the MPC was created: (i) to bring transparency and accountability to monetary policy; (ii) to reduce the risk of political pressure on a single individual; (iii) to anchor inflation expectations through a clear statutory inflation target; (iv) to align India with international best practice (UK, US, Eurozone all use committee-based decisions). The MPC publishes minutes within 14 days, which has measurably increased monetary-policy transparency.
HOT Q. Demonetisation of November 2016 was simultaneously a contractionary and expansionary monetary event. Construct a 3-step argument explaining how it could be BOTH at once. Then evaluate, with two specific evidence points, whether the policy met its stated goals.
L6 CreateHint: Contractionary side: (1) ~86% of currency in circulation was withdrawn → currency component (CU) of M1 fell sharply → narrow money contracted overnight. (2) Cash-based informal sector contracted; transactions in agriculture, retail, real estate fell for two quarters. (3) GDP growth dipped from 8.2% (Q2 FY17) to 5.6% (Q4 FY17). Expansionary side: (1) ₹15+ lakh crore returned as bank deposits → DD swelled → M1 partially recovered. (2) Bank deposit base widened, allowing banks to lower lending rates. (3) Digital payments scaled rapidly post-November 2016. Evidence on goals: (a) Black money — RBI later reported 99%+ of demonetised notes returned, suggesting limited "extinction" of black money. (b) Tax compliance — IT return filers rose from 4.0 cr (2015–16) to 6.0+ cr (2018–19); GST collections grew. Verdict: mixed success — strong on digitisation and tax base, weak on direct anti-corruption goals.
⚖️ Assertion–Reason Questions — Part 3
Options:
(A) Both A and R are true, and R is the correct explanation of A.
(B) Both A and R are true, but R is NOT the correct explanation of A.
(C) A is true, but R is false.
(D) A is false, but R is true.
(A) Both A and R are true, and R is the correct explanation of A.
(B) Both A and R are true, but R is NOT the correct explanation of A.
(C) A is true, but R is false.
(D) A is false, but R is true.
Assertion (A): When the RBI buys government securities in the open market, the money supply in the economy increases.
Reason (R): The RBI pays for the bonds with cheques, which raise the reserves of the banking system and expand the lending capacity.
Answer: (A) — Both true and R explains A. OMO purchase = injection of high-powered money. Through the multiplier, this expands M3 by several times the initial OMO amount.
Assertion (A): The repo rate is the rate at which commercial banks lend to the Reserve Bank of India.
Reason (R): Repo operations involve the RBI selling securities to banks with a promise to repurchase them at a later date.
Answer: (D) — A is false: the repo rate is the rate at which the RBI lends to commercial banks (against securities), not the other way round. R is also slightly inverted — in a repo, the bank sells securities to RBI with a promise to buy them back. The reverse repo is what A confusedly describes. Treat A as false; R, taken loosely, is broadly true. Hence (D).
Assertion (A): Demonetisation of November 2016 was implemented to curb black money, fake currency, terror financing and corruption.
Reason (R): All currency notes of ₹500 and ₹1,000 ceased to be legal tender from the night of 8 November 2016.
Answer: (B) — Both A and R are factually true, but R describes the mechanism of demonetisation, not the reason behind it. The stated objectives (A) are policy goals; the action (R) is how those goals were operationalised. So R is true but does not explain A — option (B).
3.8 Chapter Summary
Key Takeaways
- Exchange of commodities without the mediation of money is called barter exchange; it suffers from the lack of a double coincidence of wants.
- Money facilitates exchange by acting as a commonly acceptable medium of exchange. Its four functions are medium of exchange, unit of account / measure of value, store of value, and standard of deferred payments.
- People hold money for two broad motives: transactions (with precautionary as a sub-motive) and speculative. Demand for money rises with income and price level, falls with the rate of interest.
- The supply of money consists of currency notes and coins, demand and time deposits with commercial banks, and other deposits. The RBI publishes M1, M2, M3, M4 in decreasing order of liquidity. M3 is the most commonly used.
- The RBI is the monetary authority of India. Its six functions: currency authority, banker to the government, banker's bank, lender of last resort, controller of credit, and custodian of foreign exchange.
- Commercial banks create money by lending out a fraction of every deposit; the rest is held as reserves. Money Multiplier = 1 / CRR; with CRR = 10%, ₹100 of high-powered money supports ₹1,000 of deposits.
- RBI uses quantitative tools (CRR, SLR, repo rate, reverse repo, bank rate, OMO, MSF) and qualitative tools (margin requirements, moral suasion, direct credit allocation) to regulate money supply.
- Since 2016, the policy repo rate is decided by the Monetary Policy Committee (MPC), with a statutory CPI inflation target of 4% ± 2%.
- Demonetisation (8 November 2016) withdrew ₹500 and ₹1,000 notes; UPI (launched April 2016) has revolutionised digital payments in India.
3.9 Key Terms
Barter Exchange
Double Coincidence of Wants
Medium of Exchange
Unit of Account
Store of Value
Standard of Deferred Payments
Fiat Money
Legal Tender
Liquidity Preference
Liquidity Trap
Transactions Motive
Precautionary Motive
Speculative Motive
Narrow Money (M1, M2)
Broad Money (M3, M4)
High-Powered Money (M0)
Money Multiplier (1/CRR)
CRR
SLR
Repo Rate
Reverse Repo Rate
Bank Rate
Open Market Operations
MSF
Lender of Last Resort
Currency-Deposit Ratio
Reserve-Deposit Ratio
Bonds
Velocity of Circulation
MPC
Demonetisation
UPI
3.10 NCERT Exercises — Full Model Answers
Q1. What is a barter system? What are its drawbacks?
Model Answer: A barter system is one in which goods and services are exchanged directly for other goods and services, without the use of money. Drawbacks: (i) Double coincidence of wants — both parties must want exactly what the other has, simultaneously, which is rare. (ii) Lack of a common measure of value — without money there is no easy way to express the relative price of every good in terms of every other; one must remember a huge matrix of exchange ratios. (iii) Indivisibility — many goods (a cow, a tractor) cannot be physically divided to pay for a small purchase. (iv) Difficulty in storing value — perishable goods like rice or fish cannot serve as a long-term store of wealth. (v) No standard for deferred payments — long-term contracts (loans, EMIs, salaries) are nearly impossible to write in a barter economy. (vi) High search and transaction costs — the costs of finding a matching partner explode as the number of agents and goods grows.
Q2. What are the main functions of money? How does money overcome the shortcomings of a barter system?
Model Answer: Four functions of money — (i) Medium of Exchange: anyone accepts money in exchange for goods, removing the need for a double coincidence of wants. (ii) Unit of Account / Measure of Value: prices of all goods are expressed in money terms, allowing easy comparison. (iii) Store of Value: money does not perish and can be saved for future use. (iv) Standard of Deferred Payments: future contracts (loans, EMIs, rents) can be written in monetary terms. Money therefore overcomes barter's shortcomings: it removes the requirement of double coincidence; it provides a universal yardstick for value; it stores wealth easily; it makes long-term financial contracts possible.
Q3. What is transaction demand for money? How is it related to the value of transactions over a specified period of time?
Model Answer: The transaction demand for money is the demand for money balances arising from the need to carry out day-to-day transactions. People earn incomes at discrete intervals (monthly, weekly) but spend continuously, so they must hold a working cash balance. Mathematically, MTd = k · T, where T is the total nominal value of transactions in a unit period and k is a positive fraction (k = 1/v where v is the velocity of circulation of money). Hence transaction demand is directly proportional to the value of transactions: a larger volume of transactions requires a larger money balance. Linking to GDP: MTd = k · P · Y, where P is the price level and Y is real GDP. Therefore transaction demand rises with both real income and prices.
Q4. What are the alternative definitions of money supply in India?
Model Answer: The RBI publishes four measures: M1 = CU + DD + Other deposits with RBI (currency with public + net demand deposits in commercial banks + other deposits with RBI). M2 = M1 + Savings deposits with Post Office savings banks. M3 = M1 + Net time deposits with commercial banks. M4 = M3 + Total deposits with Post Office savings organisations (excluding National Savings Certificates). M1 and M2 are narrow money; M3 and M4 are broad money. They are listed in decreasing order of liquidity. M3 is the most commonly used measure of money supply, also called aggregate monetary resources.
Q5. What is a 'legal tender'? What is 'fiat money'?
Model Answer: Legal tender is currency that, by law, must be accepted by every citizen of the country in settlement of any monetary debt. In India, RBI-issued currency notes (₹2 and above) and Government-issued coins are legal tender. Cheques drawn on bank accounts are NOT legal tender — they can be refused. Fiat money is money that derives its value not from the intrinsic worth of the material it is made of, but from the legal guarantee of the issuing authority (the State / central bank). The metal in a ₹5 coin is worth less than ₹5; the paper in a ₹100 note is worth almost nothing — yet they exchange for goods and services worth their face value, because the RBI's promise stamps them with that value.
Q6. What is High Powered Money?
Model Answer: High-powered money (also called reserve money, monetary base, or M0) is the currency issued by the central bank of the country (the RBI in India). It can be held either by the public as cash in hand, or by commercial banks as cash reserves (vault cash + deposits with the RBI under CRR). It is "high-powered" because each rupee of it can support several rupees of bank deposits through the money-multiplier process — typically 5–6 times in India today. M0 is the foundation on which the RBI builds the rest of the money supply pyramid.
Q7. Explain the functions of a commercial bank.
Model Answer: Commercial banks perform three main functions. (i) Accepting deposits — savings deposits, current deposits and time/fixed deposits from households and firms. Banks pay interest on most deposits. (ii) Advancing loans — short-term and long-term loans for housing, vehicles, education, agriculture, industry and trade. The interest charged on loans exceeds the interest paid on deposits — the difference (the spread) is the bank's gross profit. (iii) Credit creation / money creation — by lending out a fraction of every deposit (keeping only required reserves), banks expand the deposit money in the economy several times beyond the original cash injection (money multiplier). Beyond these three core functions, banks offer ancillary services: cheques, demand drafts, internet/mobile banking, foreign exchange, locker facilities, advisory services and digital payments (UPI, NEFT, RTGS).
Q8. What is money multiplier? What determines the value of this multiplier?
Model Answer: The money multiplier is the ratio of total money supply to high-powered money. It tells us by how many times the total money supply is a multiple of the original currency injected. In its simplest form (no currency leakage), m = 1 / CRR. With CRR = 20%, m = 5; with CRR = 10%, m = 10. Determinants: (i) Cash Reserve Ratio (CRR) set by the RBI — higher CRR → smaller multiplier. (ii) Currency-Deposit Ratio (c) — the fraction of money the public chooses to hold as cash rather than redeposit; higher c → smaller multiplier. The general formula is
m = (1 + c) / (c + r) where r is the reserve ratio. (iii) Excess Reserve Ratio — banks may voluntarily hold reserves above CRR for safety, especially in recessions; higher excess reserves → smaller multiplier. (iv) Demand for credit — even with capacity to lend, banks need willing borrowers; in slowdowns, the realised multiplier falls.Q9. What are the instruments of monetary policy of RBI?
Model Answer: RBI's instruments are of two kinds. Quantitative (general) tools: (i) CRR (4.5%) — share of deposits held with RBI as cash. (ii) SLR (18%) — share held in liquid assets by the bank itself. (iii) Repo Rate — RBI's overnight lending rate to banks. (iv) Reverse Repo Rate / SDF — RBI's borrowing rate from banks. (v) Bank Rate — long-term lending rate (rediscount rate). (vi) Open Market Operations (OMO) — buying or selling government securities. (vii) Marginal Standing Facility (MSF) — emergency overnight borrowing window above repo. Qualitative (selective) tools: (i) Margin requirements — minimum down payment for collateral-backed loans. (ii) Moral suasion — informal persuasion of banks. (iii) Direct credit allocation — Priority Sector Lending norms (40% of net bank credit to agriculture, MSEs, weaker sections, etc.).
Q10. Do you consider a commercial bank 'creator of money' in the economy?
Model Answer: Yes. A commercial bank is a "creator of money" — but in a specific sense. It does not print money (only the RBI does). What it does is to create deposit money by lending. Mechanism: when a bank receives a primary deposit of ₹100 and CRR is 10%, it keeps ₹10 as required reserves and lends out ₹90. The borrower spends the ₹90; the recipient deposits it back into the banking system, creating a new ₹90 deposit. The bank again lends 90% of this, and so on. The cascade ends when total deposits equal ₹1,000 — the original ₹100 has multiplied tenfold. Limits: the multiplier is capped at 1/CRR; currency leakages reduce the realised multiplier; SLR, Basel III capital norms, and demand for credit further constrain it. Hence the verdict is "yes, but bounded": commercial banks are creators of money, with the RBI setting the boundaries.
Q11. What role of RBI is known as 'lender of last resort'?
Model Answer: The RBI's role of being ready to lend to commercial banks when no other source of funds is available is called the "lender of last resort". When commercial banks face a sudden liquidity shortage — for example, during a bank run, a financial market freeze, or a settlement crunch — they may approach the RBI for emergency funds. The RBI lends through facilities such as the repo window, the Marginal Standing Facility (MSF), and the discount window at the bank rate, against the collateral of approved securities. By being willing to lend in extremis, the RBI prevents an isolated stress at one bank from snowballing into a systemic banking panic. The classical articulation of the principle (Walter Bagehot, 1873) is: lend freely against good collateral, at a penalty rate.
Frequently Asked Questions
What are the main monetary policy tools used by the RBI?
The Reserve Bank of India uses two broad categories of tools. Quantitative tools change the overall quantity of money or credit — these include the repo rate, reverse repo rate, cash reserve ratio (CRR), statutory liquidity ratio (SLR), bank rate, marginal standing facility and open market operations. Qualitative tools change the direction of credit — margin requirements on loans, moral suasion, selective credit controls and direct action against errant banks. NCERT Class 12 expects students to know both lists and explain how each tool either expands or contracts money supply.
What is the repo rate and how is it different from the reverse repo rate?
The repo rate is the interest rate at which the Reserve Bank of India lends short-term money to commercial banks against government securities. The reverse repo rate is the interest rate at which the RBI borrows short-term money from commercial banks. When the RBI raises the repo rate, borrowing becomes costlier, banks pass on the higher rate to customers, and credit growth slows; when it cuts the repo rate, borrowing becomes cheaper and credit expands. The reverse repo sets the floor for short-term market rates.
What is the difference between CRR and SLR in NCERT Class 12?
The cash reserve ratio (CRR) is the fraction of total deposits that commercial banks must keep with the Reserve Bank of India as cash. The statutory liquidity ratio (SLR) is the fraction that banks must keep within themselves in approved liquid assets such as government securities, gold and cash. CRR funds earn no interest and are immobilised at the RBI, while SLR funds earn the security yield. Both ratios reduce lendable funds when raised and expand them when cut, so they directly tighten or loosen the money multiplier 1/CRR.
What are open market operations (OMO) of the RBI?
Open market operations are the buying and selling of government securities by the RBI in the open bond market. When the RBI sells securities, it absorbs cash from banks, shrinking reserves and money supply — a contractionary OMO. When it buys securities, it pays cash into the system, expanding reserves and money supply — an expansionary OMO. NCERT Class 12 emphasises that OMOs are flexible day-to-day tools, unlike the CRR or SLR which require formal policy notifications and operate with a lag.
What are the qualitative or selective credit control tools?
Qualitative tools change the direction of credit rather than its overall quantity. Margin requirements raise the down-payment fraction for specific loans (such as housing or commodities) to discourage speculative borrowing. Moral suasion is the RBI persuading banks informally to follow its policy stance. Selective credit controls direct banks to expand or restrict credit to specific sectors, such as agriculture or priority lending. These tools matter when the RBI wants to slow speculation in one market without raising interest rates for the whole economy.
How are the NCERT Class 12 Chapter 3 exercise questions structured?
Chapter 3 exercises mix definition-style questions, comparison-style questions and short numerical applications. Typical asks include: define money and list its functions, distinguish M1 and M3, explain how commercial banks create money, calculate the deposit multiplier given the CRR, list quantitative and qualitative monetary policy tools, and explain the RBI's role as banker to banks. Part 3 of this lesson provides a complete model answer for every Chapter 3 exercise so students can match their own answers against a standard board-quality response.
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