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CHAPTER: 1
INTRODUCTION OF
MONETARY POLICY
a. MEANING:
Monetary policy is the process by which the government, central bank, or monetary
authority of a country controls:
a. the supply of money,
b. Availability of money, and
c. Cost of money or rate of interest, in order to attain a set of objectives oriented
towards the growth and stability of the economy.Monetary theory provides
insight into how to craft optimal monetary policy.

Monetary policy is one of the tools that a national Government uses to influence its
economy. Using its monetary authority to control the supply and availability of money, a
government attempts to influence the overall level of economic activity in line with its
political objectives. Usually this goal is "macroeconomic stability" - low unemployment,
low inflation, economic growth, and a balance of external payments. Monetary policy is
usually administered by a Government appointed "Central Bank", the Bank of Canada and
the Federal Reserve Bank in the United States. According to the Encarta the definition of
monetary policy is the following economic principles and programs adopted by a
government that manage the growth of its money supply, the availability of credit, and
interest rates. In the United States, the Federal Reserve Board determines monetary policy.

1.2 WHAT ARE THE GOALS OF MONETARY POLICY:

• Goals of monetary policy are to promote maximum employment, inflation
(stabilizing prices), and economic growth.
• One goal of the fed is to affect the economic production and employment, both
of which depend on many other factors. But they can be influenced by monetary
policy; when demand weakens, the fed lowers interest rates, which in turn stimulates
the economy. But continuous stimulus will push the economy's inflation higher and
higher, so the fed just tries to smooth out the bumps of natural business cycle.
 • Inflation is an economy wide rise in prices which is bad because it makes it
hard to tell if a business product price is going up because of higher demand or
inflation. Inflation also adds premium to long-term interest rates. There's a lot of
debate about whether zero inflation is a target. Some people say that when inflation
is low, interest rates are low so the fed doesn't have much room to boost the economy
if it needs to. Also, when inflation is close to zero there is more risk of deflation.
• Deflation is when there is a nation wide fall in prices. Sounds good if you're a
consumer, but really it is just as bad as inflation. A prolonged deflation, like the great
depression, can lead to significant declines in home and business values. Also, with
low prices come low interest rates, and less room for the fed to stimulate the
economy. The main goal is to keep the economy steady, not too high or low. The
feds monitor the stock market closely too, for indicators on the economy.

• Monetary policy rests on the relationship between the rates of interest in an

economy, that is the price at which money can be borrowed, and the total supply of
money. Monetary policy uses a variety of tools to control one or both of these, to
influence outcomes like economic growth, inflation, exchange rates with other
currencies and unemployment. Where currency is under a monopoly of issuance, or
where there is a regulated system of issuing currency through banks which are tied to
a central bank, the monetary authority has the ability to alter the money supply and
thus influence the interest rate (in order to achieve policy goals). The beginning of
monetary policy as such comes from the late 19th century, where it was used to
maintain the gold standard.
a. CONTENTS OF MONETARY POLICY:

In practice, all types of monetary policy involve modifying the amount of base currency
(M0) in circulation. This process of changing the liquidity of base currency through the
open sales and purchases of (government-issued) debt and credit instruments is called open
market operations.
Constant market transactions by the monetary authority modify the supply of currency and
this impacts other market variables such as short term interest rates and the exchange rate.
The distinction between the various types of monetary policy lies primarily with the set of
instruments and target variables that are used by the monetary authority to achieve their
goals.
Monetary Policy: Target Market Variable: Long Term Objective:
Inflation Targeting Interest rate on overnight A given rate of change in the CPI
debt
Price Level Interest rate on overnight A specific CPI number
Targeting debt
Monetary The growth in money A given rate of change in the CPI
Aggregates supply
Fixed Exchange The spot price of the The spot price of the currency
Rate currency
Gold Standard The spot price of gold Low inflation as measured by the
gold price
Mixed Policy Usually interest rates Usually unemployment + CPI change

The different types of policy are also called monetary regimes, in parallel to exchange rate
regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results
in a relatively fixed regime towards the currency of other countries on the gold standard and
a floating regime towards those that are not. Targeting inflation, the price level or other
monetary aggregates implies floating exchange rate unless the management of the relevant
foreign currencies is tracking the exact same variables (such as a harmonized consumer
price index).
• INFLATION TARGETING:
Under this policy approach the target is to keep inflation, under a particular definition such
as Consumer Price Index, within a desired range.
The inflation target is achieved through periodic adjustments to the Central Bank interest
rate target. The interest rate used is generally the inter bank rate at which banks lend to each
other overnight for cash flow purposes. Depending on the country this particular interest
rate might be called the cash rate or something similar.
• PRICE LEVEL TARGETING:
Price level targeting is similar to inflation targeting except that CPI growth in one year is
offset in subsequent years such that over time the price level on aggregate does not move.
• MONEY AGGREGATES:
In the 1980s, several countries used an approach based on a constant growth in the
money supply. This approach was refined to include different classes of money and
credit (M0, M1 etc). In the USA this approach to monetary policy was discontinued
with the selection of Alan Greenspan as Fed Chairman.
This approach is also sometimes called monetarism.
While most monetary policy focuses on a price signal of one form or another, this approach
is focused on monetary quantities.
• FIXED EXCHANGE RATE:
This policy is based on maintaining a fixed exchange rate with a foreign currency.
There are varying degrees of fixed exchange rates, which can be ranked in relation to
how rigid the fixed exchange rate is with the anchor nation.
Under a system of fiat fixed rates, the local government or monetary authority declares a
fixed exchange rate but does not actively buy or sell currency to maintain the rate. Instead,
the rate is enforced by non-convertibility measures (e.g. capital controls, import/export
licenses, etc.). In this case there is a black market exchange rate where the currency trades
at its market/unofficial rate.
Under a system of fixed-convertibility, currency is bought and sold by the central bank or
monetary authority on a daily basis to achieve the target exchange rate. This target rate may
be a fixed level or a fixed band within which the exchange rate may fluctuate until the
monetary authority intervenes to buy or sell as necessary to maintain the exchange rate
within the band. (In this case, the fixed exchange rate with a fixed level can be seen as a
special case of the fixed exchange rate with bands where the bands are set to zero.)
Under a system of fixed exchange rates maintained by a currency board every unit of local
currency must be backed by a unit of foreign currency (correcting for the exchange rate).
This ensures that the local monetary base does not inflate without being backed by hard
currency and eliminates any worries about a run on the local currency by those wishing to
convert the local currency to the hard (anchor) currency.
Under dollarization, foreign currency (usually the US dollar, hence the term "dollarization")
is used freely as the medium of exchange either exclusively or in parallel with local
currency. This outcome can come about because the local population has lost all faith in the
local currency, or it may also be a policy of the government (usually to rein in inflation and
import credible monetary policy).
These policies often abdicate monetary policy to the foreign monetary authority or
government as monetary policy in the pegging nation must align with monetary policy in
the anchor nation to maintain the exchange rate. The degree to which local monetary policy
becomes dependent on the anchor nation depends on factors such as capital mobility,
openness, credit channels and other economic factors.
• GOLD STANDARD:
The gold standard is a system in which the price of the national currency as measured
in units of gold bars and is kept constant by the daily buying and selling of base
currency to other countries and nationals. (I.e. open market operations cf. above). The
selling of gold is very important for economic growth and stability.
The gold standard might be regarded as a special case of the "Fixed Exchange Rate" policy.
And the gold price might be regarded as a special type of "Commodity Price Index".
Today this type of monetary policy is not used anywhere in the world, although a form of
gold standard was used widely across the world prior to 1971. Its major advantages were
simplicity and transparency.
a. TOOLS OF MONETARY POLICY:
• MONETARY BASE:
 Monetary policy can be implemented by changing the size of the monetary base. This
directly changes the total amount of money circulating in the economy. A central bank
can use open market operations to change the monetary base. The central bank would
buy/sell bonds in exchange for hard currency. When the central bank
disburses/collects this hard currency payment, it alters the amount of currency in the
economy, thus altering the monetary base.
• RESERVE REQUIREMENTS:
The monetary authority exerts regulatory control over banks. Monetary policy can be
implemented by changing the proportion of total assets that banks must hold in
reserve with the central bank. Banks only maintain a small portion of their assets as
cash available for immediate withdrawal; the rest is invested in illiquid assets like
mortgages and loans. By changing the proportion of total assets to be held as liquid
cash, the Federal Reserve changes the availability of loanable funds. This acts as a
change in the money supply.
• DISCOUNT WINDOW LENDING:
Many central banks or finance ministries have the authority to lend funds to financial
institutions within their country. By calling in existing loans or extending new loans,
the monetary authority can directly change the size of the money supply
.
• INTEREST RATES:
The contraction of the monetary supply can be achieved indirectly by increasing the
nominal interest rates. Monetary authorities in different nations have differing levels of
control of economy-wide interest rates. In the United States, the Federal Reserve can set the
discount rate, as well as achieve the desired Federal funds rate by open market operations.
This rate has significant effect on other market interest rates, but there is no perfect
relationship. In the United States open market operations are a relatively small part of the
total volume in the bond market. One cannot set independent targets for both the monetary
base and the interest rate because they are both modified by a single tool — open market
operations; one must choose which one to control.
In other nations, the monetary authority may be able to mandate specific interest rates on
loans, savings accounts or other financial assets. By raising the interest rate(s) under its
control, a monetary authority can contract the money supply, because higher interest rates
encourage savings and discourage borrowing. Both of these effects reduce the size of the
money supply.
• CURRENTY BOARD:
 A currency board is a monetary arrangement that pegs the monetary base of one
country to another, the anchor nation. As such, it essentially operates as a hard fixed
exchange rate, whereby local currency in circulation is backed by foreign currency
from the anchor nation at a fixed rate. Thus, to grow the local monetary base an
equivalent amount of foreign currency must be held in reserves with the currency
board.
This limits the possibility for the local monetary authority to inflate or pursue other
objectives. The principal rationales behind a currency board are three-fold:
1. To import monetary credibility of the anchor nation;
2. To maintain a fixed exchange rate with the anchor nation;
3. To establish credibility with the exchange rate (the currency board arrangement is the
hardest form of fixed exchange rates outside of dollarization).
a. TYPES OF MONETARY POLICY:

1. EXPANSIONARY MONETARY POLICY:

Expansionary monetary policy is when the Federal Reserve is using its tools to
stimulate the economy. This usually means lowering the Fed Funds rate to increase
the money supply. This will cause mortgage rates to decline, consumers to borrow
and spend, and businesses to grow, thereby hiring more workers who will consume
even more. The opposite is contractionary monetary policy.
• Points related with Expansionary Monetary Policy:
1. Expansionary monetary policy causes an increase in bond prices and a reduction in
interest rates.
2. Lower interest rates lead to higher levels of capital investment.
3. The lower interest rates make domestic bonds less attractive, so the demand for
domestic bonds falls and the demand for foreign bonds rises.
4. The demand for domestic currency falls and the demand for foreign currency rises,
causing a decrease in the exchange rate. (The value of the domestic currency is now
lower relative to foreign currencies)
5. A lower exchange rate causes exports to increase, imports to decrease and the
balance of trade to increase.

2. CONTRACTIONARY MONETARY POLICY:

Contractionary monetary policy is when the Federal Reserve is using its tools to put
the brakes on the economy to prevent inflation. This usually means raising the Fed
Funds rate to decrease the money supply. This will cause mortgage rates to increase,
consumers to borrow and spend less, and businesses to stop raising prices and giving
raises. This usually heads off inflation.
• Points related with Contractionary Monetary Policy:
1. Contractionary monetary policy causes a decrease in bond prices and an increase in
interest rates.
2. Higher interest rates lead to lower levels of capital investment.
3. The higher interest rates make domestic bonds more attractive, so the demand for
domestic bonds rises and the demand for foreign bonds falls.
4. The demand for domestic currency rises and the demand for foreign currency falls,
causing an increase in the exchange rate. (The value of the domestic currency is now
higher relative to foreign currencies)
5. A higher exchange rate causes exports to decrease, imports to increase and the
balance of trade to decrease.

TERMS INVOLVED IN MONETARY POLICY

a.
6. Bank Rate
7. Repo Rate
8. Reverse Repo Rate
9. Cash Reserve Ratio
10. Statutory Liquidity Ratio

1. Bank Rate: Bank Rate is the rate at which central bank of the country allows
finance to commercial banks. Bank Rate is a tool, which central bank uses for short-
term purposes. Any upward revision in Bank Rate by central bank is an indication
that banks should also increase deposit rates as well as Prime Lending Rate. This any
revision in the Bank rate indicates could mean more or less interest on your deposits
and also an increase or decrease in your EMI. (present rate is 6% as on 19/03/2010).

2. Repo Rate: Repo rate is the rate at which our banks borrow rupees from RBI.
This facility is for short term measure and to fill gaps between demand and supply of
money in a bank .when a bank is short of funds they borrow from bank at repo rate
and if bank has a surplus fund then the deposit the funds with RBI and earn at
Reverse repo rate present rate is 5.00% as on 19/03/2010).

3. Reverse Repo Rate: Reverse Repo rate is the rate which is paid by RBI to
banks on Deposit of funds with RBI.A reduction in the repo rate will help banks to
get money at a cheaper rate. When the repo rate increases borrowing from RBI
becomes more expensive. To borrow from RBI bank have to submit liquid
bonds/Govt. Bonds as collateral security, so this facility is a short term gap filling
facility and bank does not use this facility to Lend more to their customers. (present
rate is 3.50% as on 19/03/2010).
 4. Cash Reverse Ratio: Cash reserve Ratio (CRR) is the amount of Cash(liquid
cash like gold) that the banks have to keep with RBI. This Ratio is basically to secure
solvency of the bank and to drain out the excessive money from the banks. If RBI
decides to increase the percent of this, the available amount with the banks comes
down and if RBI reduce the CRR then available amount with Banks increased and
they are able to lend more. Present rate is (5.75% as on 19/03/2010).

5. Statutory Liquidity Ratio: Statutory Liquidity Ratio is the amount a

commercial bank needs to maintain in the form of cash, or gold or govt. approved
securities (Bonds) before providing credit to its customers. SLR rate is determined
and maintained by the RBI (Reserve Bank of India) in order to control the expansion
of bank credit. Generally this mandatory ration is complied by investing in Govt.
bonds present rate of SLR is 25%. (as on 19/03/2010).

CHAPTER: 2
REVIEW OF LITERATURE
REVIEW OF LITERATURE
A review of literature is a body of text that aims to review the critical points of current
knowledge and or methodological approaches on a particular topic. Literature reviews are
secondary sources, and as such, do not report any new or original experimental work. A
well-structured literature review is characterized by a logical flow of ideas; current and
relevant references with consistent, appropriate referencing style; proper use of
terminology; and an unbiased and comprehensive view of the previous research on the
topic.
Stacey L. Schreft , Bruce D. Smith (2001)1 Studied that in many countries, government-
budget surpluses has led to a decline in the amount of federal government debt outstanding.
This paper considers the consequences of this development for a central bank that conducts
monetary policy through open market operations in treasury debt. A model is presented in
which a treasury taxes, spends, and issues debt; a central bank conducts monetary policy
through open market operations; and banks are intermediaries for all private savings. The
model suggests potentially severe consequences from a shrinking stock of government debt
in the absence of a change in the conduct of monetary policy. Specifically, the nominal
interest rate and the inflation rate cannot be below their seigniorage-maximizing levels. In
effect, a small stock of debt combined with restrictions on a central bank's portfolio can put
the economy on the Pareto inferior side of the seigniorage Laffer curve, with an
unnecessarily high inflation rate and nominal interest rate. Moreover, if the government also
runs a primary budget deficit, equilibrium can fail to exist. The model presented can yield
estimates of how much debt must be outstanding to avoid each situation. Discount-window
lending is a feasible - and desirable - alternative method for conducting monetary policy.

Alicia García-Herrero (2003) Studied paper builds upon the existing empirical literature
on the factors behind financial stability, focusing on the role of monetary policy design. In
particular, it analyzes a sample of 79 countries in the period 1970 to 1999 to evaluate the
effect of the choice of the central bank objectives and the monetary policy strategy on the
occurrence of banking crises. We find that focusing the central bank objectives on price
stability reduces the likelihood of a banking crisis. This result is robust, in general, to
several model specifications and groups of countries. As for the monetary policy strategy,
the results are less clear. For a few model specifications, particularly for the group of
countries in transition, the choice of an exchange rate-based strategy appears to reduce the
likelihood of a banking crisis. Finally, a large degree of independence of the central bank
and locating regulatory and supervisory responsibilities at the central bank seem to reduce
the likelihood of a banking crisis.

David H. Small,
Rasmus Fatum , Barry Scholnick (2005) Studied that this paper shows that exchange
rates respond to only the surprise component of an actual US monetary policy change and
that failure to disentangle the surprise component from the actual monetary policy change
can lead to an underestimation of the impact of monetary policy, or even to a false
acceptance of the hypothesis that monetary policy has no impact on exchange rates. This
finding implies that there is a need for reexamining the empirical analyses of asset price
responses to macro news that do not isolate the unexpected component of news from the
expected element. In addition, we add to the debate on how quickly exchange rates respond
to news by showing that the exchange rates under study absorb monetary policy surprises
within the same day as the news are announced.
Francis Y. Kumah (2006) Studied that adequate modeling of the seasonal structure of
consumer prices is essential for inflation forecasting. This paper suggests a new
econometric approach for jointly determining inflation forecasts and monetary policy
stances, particularly where seasonal fluctuations of economic activity and prices are
pronounced. In an application of the framework, the paper characterizes and investigates the
stability of the seasonal pattern of consumer prices in the Kyrgyz Republic and estimates
optimal money growth and implied exchange rate paths along with a jointly determined
inflation forecast. The approach uses two broad specifications of an augmented error-
correction model - with and without seasonal components. Findings from the paper confirm
empirical superiority (in terms of information content and contributions to policymaking) of
augmented error-correction models of inflation over single-equation, Box-Jenkins-type
general autoregressive seasonal models. Simulations of the estimated error-correction
models yield optimal monetary policy paths for achieving inflation targets and demonstrate
the empirical significance of seasonality and monetary policy in inflation forecasting.
Karlygash Kuralbayeva (2007) We analyze implications of inflation persistence for
business cycle dynamics following terms of trade and risk-premium shocks in a small open
economy, under fixed and flexible exchange rate regimes. We show that the country's
adjustment paths are slow and cyclical if there is a significant backward-looking element in
the inflation dynamics and the exchange rate is fixed. We also show that such cyclical
adjustment paths are moderated if there is a high proportion of forward-looking price
setters. In contrast, with an independent monetary policy, flexible exchange rate allows to
escape severe cycles, supporting the conventional wisdom about the insulation role of
flexible exchange rates.
Alessandro Calza et al. (2009) studied how the structure of housing finance affects the
transmission of monetary policy shocks. We document three main facts: first, the features
of residential mortgage markets differ markedly across industrialized countries; second, and
according to a wide range of indicators, the transmission of monetary policy shocks to
residential investment and house prices is significantly stronger in those countries with
larger flexibility/development of mortgage markets; third, the transmission to consumption
is stronger only in those countries where mortgage equity release is common and mortgage
contracts are predominantly of the variable-rate type. We build a two-sector DSGE model
with price stickiness and collateral constraints and analyze how the response of
consumption and residential investment to monetary policy shocks is affected by alternative
values of two institutional features: (i) down-payment rate; (ii) interest rate mortgage
structure (variable vs. fixed rate). In line with our empirical evidence, the sensitivity of both
variables to monetary policy shocks increases with lower values of the down-payment rate
and is larger under a variable- rate mortgage structure.
Petra M. Geraats (2009) Studied that transparency has become a prominent feature of
monetary policy. This paper provides an overview of central bank communication practices
and is the first to systematically analyze transparency trends throughout the world and
across monetary policy frameworks. It shows that increases in information disclosure have
not been confined to inflation targeting but extend to other monetary policy frameworks,
although there are significant differences. In addition, countries with higher inflation and
economic development have undergone larger increases in transparency. Moreover, it
shows that greater transparency has been followed by lower average inflation.
REFERENCES:
• Stacey L. Schreft , Bruce D. Smith , 2001, “The Conduct of Monetary Policy
with a Shrinking Stock of Government” FRB of Kansas City Research Working
Paper No. 01-09

• Alicia García-Herrero , Pedro Del Rio Lopez . 2003, “ Financial Stability and
the Design of Monetary Policy” Banco de Espana Working Paper No. 0315
 • David H. Small , James A. Clouse , 2004, The Scope of Monetary Policy
Actions Authorized under the Federal Reserve Act FEDS Working Paper No. 2004-
40

• Francis Y. Kumah 2006 The Role of Seasonality and Monetary Policy in

Inflation Forecasting , IMF Working Paper No. 06/175

• Karlygash Kuralbayeva ,2007, “Inflation Persistence: Implications for a Design

of Monetary Policy in a Small Open Economy Subject to External Shocks”,CEIS
Working Paper No. 95

• Alessandro Calza et al., 2009, Housing Finance and Monetary Policy, ECB
Working Paper No. 1069

• Petra M. Geraats ,2009, Trends in Monetary Policy Transparency,

CESifo Working Paper Series No. 2584

CHAPTER: 3
RESEARCH
METHODOLOGY
3.1 RESEARCH METHODOLOGY:
Research in common parlance refers to a search for knowledge. One can also define
research as a scientific and systematic search for pertinent information on a specific topic.
3.2 OBJECTIVE OF THE STUDY:
• To know the different rates of monetary policy in India.
• To know frequency of movements in different rates of Monetary Policy.
• To know the impact of changes in different rates of Monetary Policy on the
Indian economy.
• To find the variability of Bank Rate, Cash Reserve Ratio, Repo Rate & Reverse
Repo Rate.
• To find the relationship between the Repo Rate and Reverse Repo Rate.
3.3 CONTENTS INCLUDE IN THE STUDY:
a. Scope of Study
b. Type of Research Design
c. Data Collection Method
d. Statistical Tools Used in the Study
e. Time Period taken for the Study

a) SCOPE OF STUDY:
• To study the frequency of movements in Monetary Policy in
India.
• To know the impact of changes in interest rates on Inflation.

b) TYPES OF RESEARCH DESIGN

Research design can be classified into following types:-
• Descriptive research design
• Exploratory research design
• Experimental research design
In this project I have used descriptive research design.
c) DATA COLLECTION METHOD:
• Secondary Sources of Data

The data collection is the foundation of any study. The Secondary data on is characterized
by the data being collected not exactly for the project writing, but have to drive-it-out from
the record, documents, newspapers, other published material available & the help of
Internet.

d) Statistical Tools used for the Study:

• Mean: In statistics, the mean is the mathematical average of a set of numbers.
The average is calculated by adding up two or more scores and dividing the total by
the number of scores.

• Standard Deviation: It shows how much variation there is from the

"average" (mean). A low standard deviation indicates that the data points tend to be
 very close to the mean, whereas high standard deviation indicates that the data are
spread out over a large range of values.

• Correlation: A correlation is a single number that describes the degree of

relationship between two variables

• Tables: Various tables used for the analysis of different rates used in
Monetary Policy.

• Graphs: Line Graphs used for the study.

e) Time Period taken for the Study: I used data for the study from
28/04/2005 to 19/03/2010.

3.4 LIMITATIONS OF THE STUDY:

Limitations of the study are all those which a student has to face while completing
such project. However, following are the main limitations:

a. Time availability:- The time of research will be short due to which many fact
may remain untouched
b. Data availability: There can be limitation of the data accuracy.
c. The Statistical technique which used have there own limitation.
d. Interpretation was manual that can differ from person to person.
e. I had done my best within my limitations to do justice to my project.

CHAPTER: 4
 ANALYSIS &
interpretation

MAJOR INGRIDIENTS OF MONETARY POLICY:

a. Bank Rate
b. Cash Reserve Ratio
c. Repo Rate
d. Reverse Repo Rate
e. Prime lending Rates
f. Find the relationship between the Repo Rate
& Reverse Repo Rate
g. Find the relationship between the Repo Rate
& Cash Reserve Ratio
h. Find the relationship between the Reverse
Repo Rate & Cash Reserve Ratio

4.1
BANK RATE
BANK RATE:
Introduction:
Bank rate is referred to the rate of interest charged by premier banks on the loans and
advances. Bank rate varies based on some defined conditions as laid down the governing
authority of the banks. Bank rates are levied to control the money supply to and from the
bank.
Meaning of bank rate:
From the consumer's point of view, bank rate ordinarily denotes to the current rate of
interest acquired from savings certificate of Deposit. It is most frequently used by the
consumers who are concerned in mortgage.
Bank rate types:
Some commonest types of bank interest rates are as follows:
• Bank rate on CD, i.e., on certificate of deposit
• Bank rate on the credit of a credit card or other kind of loan
• Bank rate on real estate loan
Interest Rates:
Bank interest rate can be defined as the fee paid on borrowed money. The amount loaned
is called the principal and the share of the principal that is paid as interest over a defined
period of time, is called the interest rate. The bank rate or bank rate of interest is
normally classified as:
• Simple interest: Mathematically, simple interest rate can be defined as the
result of the product of the principal, the rate of interest and the number of time
periods. The calculation is based on the original principal amount. For example, $200
on deposit at 12% simple interest would yield $24 per year.
• Compound interest: Mathematically, the procedure of calculating compound
interest is almost similar to the calculation of simple interest rate, with only one
exception. The principal varies with every time period, whereas the principal remains
the same in case of simple interest calculation. At the end of every time period, the
new principal will be previous principal plus the amount of interest on the previous
principal. Compound interest rate is alternatively termed as annual percentage rate,
effective annual rate, and effective interest rate.
• Real interest: Real interest rate is equal to the current interest rate minus
inflation rate(inflation rate is defined as the rate of decrease on buying power of
money ) or alternatively calculated as the nominal interest rate minus inflation. The
basic function of calculating real interest is to measure the value of the interest in
units on buying power.
 • Cumulative interest: This type of bank rate interest is calculated to ascertain
which loan amount will be most economical in nature. For The sum of all interest
payments made on a loan over a certain time period. The calculation of cumulative
interest is done by subtracting one from the ratio of future value and present value.

666666666666666666
6 6 6 6 BANK RATES BANK
RATES
MEAN
19/03/2010
29/01/2010
27/10/2009
28/07/2009
21/04/2009
27/01/2009
24/10/2008
27/07/2008
29/04/2008
29/01/2008
30/10/2007
31/07/2007
24/04/2007
31/01/2007
31/10/2006
25/07/2006
18/04/2006
24/01/2006
25/10/2005
26/07/2005
28/04/2005
RATES IN PERCENTAGE
TIME PERIOD
 (TABLE 1)
TABLE NO. 1
GRAPH NO. 1
Interpretation:
As indicated in Table 1, Bank Rate from 24/04/2005 to 19/03/2010 is constant i.e.
6%. There is no change in the Bank Rate within this period. So the Mean in this
period is also 6% and there is no variability in the Bank Rate.

4.2
 CASH RESERVE RATIO
Cash Reserve Ratio (CRR):
• It is a bank regulation that sets the minimum reserves each
bank must hold by way of customer deposits and notes.
• These deposits are designed to satisfy cash withdrawal
demands of customers.
• Deposits are normally in the form of currency stored in a
bank vault or with the central bank like the RBI.
• CRR is also called the Liquidity Ratio as it seeks to control
money supply in the economy

Effects on Money Supply:

• CRR is used as a tool in monetary policy, influencing the
country’s economy, borrowing and interest rates.
• CRR works like brakes on the economy’s money supply.
• CRR requirements affect the potential of the banking
system to create higher or lower money supply.
• Let us now understand how CRR requirements affects the
potential of banks to ‘create’ higher or lower money supply

CRR and Liquidity:

• For e.g. say…the CRR is pegged by RBI at 10%. if a bank
receives Rs. 100 as deposit, then they can lend Rs. 90 as a loan
and will have to keep the balance Rs. 10 in customer’s deposit
account.
 • Now, the borrower who has received Rs. 90 as a loan will
deposit the same in his bank.
• The borrower’s bank will now lend out Rs. 81 (Rs. 90 X
90%) and keep Rs. 9 in his deposit account.
• As this process continues, the banking system can expand
the initial deposit of Rs.100 into a maximum of Rs. 1000 (Rs.
100 + Rs. 90 + Rs. 81….=Rs. 1000).
• For e.g. say…the CRR is pegged by RBI at 20%. if a bank
receives Rs. 100 as deposit, then they can lend Rs. 80 as a loan
and will have to keep the balance Rs. 20 in customer’s deposit
account.
• Now, the borrower who has received Rs. 80 as a loan will
deposit the same in his bank.
• The borrower’s bank will now lend out Rs. 64 (Rs. 80 X
80%) and keep Rs. 16 in his deposit account.
• As this process continues, the banking system can expand
the initial deposit of Rs.100 into a maximum of Rs. 500 (Rs.
100 + Rs. 80 + Rs. 64….=Rs. 500)

Results:
• The higher the cash reserve (CRR) required, the lower the
money available for lending.
• Every time the borrowed money comes into a deposit
account of a customer, the bank has to compulsorily keep a part
of it as reserves.
• This reduces credit expansion by controlling the amount of
money that goes out by way of loans.
• This directly affects money creation process and in turn
affects the economic activity.
 • Hence central banks in the world increase the requirement
of cash reserves whenever they feel the need to control money
supply.
• CRR is increased to bring down inflation which happens
due to excessive spending power.
• Spending power is augmented by loans - if money that goes
out as loans is controlled, inflation can be tamed to some extent.
• Conversely, if the government wants to stimulate higher
economic activity and encourage higher spending to achieve
economic growth, they will lower CRR.
• A lower CRR allows the bank to lend more money and will
fuel consumption and spending.
• Thus…banks indirectly enjoy the power to create more
money.

5.75 5.75 5 5 5 5 6.5 9 8.75 7.75

7.5 7.5 7 7 6.5 6.5 5.5 5 5 5 5 5 5 5
CASH RESERVE RATIO
CASH RESERVE RATIO
19/03/2010
29/01/2010
27/10/2009
28/07/2009
21/04/2009
27/01/2009
24/10/2008
30/08/2008
29/07/2008
29/04/2008
29/01/2008
10/11/2007
30/10/2007
07/08/2007
31/07/2007
24/04/2007
31/01/2007
31/10/2006
25/07/2006
18/04/2006
24/01/2006
25/10/2005
26/07/2005
28/04/2005
RATES IN PERCENTAGE
TIME PERIOD

TABLE NO. 2
MEAN 6.08
1.29
STANDARD
DEVIATION
GRAPH NO. 2
Interpretation:
As indicated in Table 2, CRR was constant from the period of 28/04/2005 to
31/10/2006 which was 5%. After that it start increasing upto 9% in 30/08/2008
which was the peak rate in this time period. From 24/10/2008 the CRR starts
decreasing at 5% upto 27/10/2009. After this period the rate show increasing trend
and on 19/03/2010 the current
CRR was 5.75%.
The Average of CRR is 6.08 and Standard Deviation is 1.29 from the period of
24/04/2005 to 19/03/2010 which indicate the variability of the CRR.

4.3
REPO RATE

Repo Rate:
Repo rate is the rate at which the banks can borrow money from a
central bank of the country in order to avoid scarcity of funds. For
e.g., whenever the banks have any shortage of funds they can borrow
it from Reserve Bank of India (RBI). Thus Repo rate is the rate at
which our banks borrow rupees from RBI. A reduction in the repo
rate will help banks to get money at a cheaper rate. When the repo
rate increases borrowing from RBI becomes more expensive. It is
also a financial & economic tool in the hands of government to
control the availability of money supply in the market by altering the
repo rate from time to time.

5 4.75 4.75 4.75 4.5 5.5 8 9

7.5 7.75 7.75 7.75 7.75 7.5
7.25 7 6.5 6.5 6.25 6 6
REPO RATE REPO RATE
19/03/2010
29/01/2010
27/10/2009
28/07/2009
21/04/2009
27/01/2009
24/10/2008
27/07/2008
29/04/2008
29/01/2008
30/10/2007
31/07/2007
24/04/2007
31/01/2007
31/10/2006
25/07/2006
18/04/2006
24/01/2006
26/10/2005
26/07/2005
28/04/2005
RATE IN PERCENTAGE
TIME PERIOD

TABLE NO. 3
MEAN 6.56
1.31
STANDARD
DEVIATION
 GRAPH NO. 3
Interpretation:
As indicated in Table 3, Repo Rate was 6% on 28/04/05, after that it was it showed
an increasing trend reach to peak on 27/27/08 to 9%. After that it start decreasing
upto 4.75% on 29/01/10. The current Repo Rate is 5%.
The Average of Repo Rate is 6.56 and Standard Deviation is 1.31 from the period
of 24/04/2005 to 19/03/2010 which indicate the variability of the Repo Rate.

4.4
REVERSE REPO RATE
Reverse Repo Rate:
Reverse Repo rate is the rate at which Reserve Bank of India (RBI) borrows money from
banks. Banks are always happy to lend money to RBI since their money are in safe hands
with a good interest. An increase in Reverse repo rate can cause the banks to transfer more
funds to RBI due to these attractive interest rates. It can cause the money to be drawn out of
the banking system.
Due to this fine tuning of RBI using its tools of CRR, Bank Rate, Repo Rate and Reverse
Repo rate our banks adjust their lending or investment rates for common man.

3.5 3.25 3.25 3.25 3.25 4 6 6

6 6 6 6 6 5.5 5 5 5.5 5.5 5.25
4.75 4.75 REVERSE REPO
RATE REVERSE REPO
RATE
19/03/2010
29/01/2010
27/10/2009
28/07/2009
21/04/2009
27/01/2009
24/10/2008
29/07/2008
29/04/2008
29/01/2008
30/10/2007
31/07/2007
24/04/2007
31/01/2007
31/10/2006
25/07/2006
18/04/2006
24/01/2006
26/10/2005
26/07/2005
28/04/2005
RATES IN PERCENTAGE
TIME PERIOD
 TABLE NO. 4
MEAN 4.94
1.08
STANDARD
DEVIATION
GRAPH NO. 4
Interpretation: As indicated in Table 4, on 28/04/05 Reverse Repo Rate was 4.75%, after
that it was showed an increasing trend and it was 5.5% on 18/04/06. Then it was start
decreasing till 31/10/06 upto 5%, again it was start to increasing till 24/10/08 at 6%. Again
it was start to decreasing till 29/01/10 to 3.25% and now it is 3.5% on 19/03/2010.
The Average of Reverse Repo Rate is 4.94 and Standard Deviation is 1.08 from the period
of 24/04/2005 to 19/03/2010 which indicate the variability of the Reverse Repo Rate.

4.5
PRIME LENDING RATES
Prime Lending Rates:
These are the rate of interest charged by the banks for the loans given. These rates vary
from bank to bank. Although RBI has partial control over deciding of such rates still then
such rates vary from bank to bank, either private or public bank, according to their own
policy.

4.6
relationship between
the repo rate & reverse
Repo Rate
3.5 29/01/2010 3.25 4.75 4.75 29/04/2008 REVERSE
27/10/2009 3.25 3.25 RREPO RATE REVERSE
27/01/2009 4 5.5 6 29/07/2008 EREPO RATE
6 7.5 7.75 7.75 30/10/2007 6 P
7.75 31/07/2007 6 7.75 O
24/04/2007 6 7.5 31/01/2007
5.5 7.25 31/10/2006 5 7 R
25/07/2006 5 6.5 18/04/2006 A
5.5 6.5 24/01/2006 5.5 6.25 T
26/10/2005 5.25 6 26/07/2005 E
4.75 6 28/04/2005 4.75 TIME
PERIOD RATES IN 2
PERCENTAGE REPO RATE 4
19/03/2010 /
27/10/2009 1
21/04/2009 0
27/01/2009 /
27/07/2008 2
29/04/2008 0
29/01/2008 0
30/10/2007 8
31/07/2007
24/04/2007
31/01/2007
31/10/2006
25/07/2006
18/04/2006
24/01/2006
26/10/2005
26/07/2005
28/04/2005
19/03/2010 5 4.75
28/07/2009 3.25
21/04/2009 4.5 8
24/10/2008 6 9
29/01/2008 6 RATE
IN PERCENTAGE
29/01/2010
28/07/2009
TIME PERIOD

TABLE NO. 6

CORRELATION BETWEEN 0.94 Perfect

REPO & REVERSE REPO RATE Related
Correlated

TABLE NO. 6
Interpretation:
As shown in Table 6 that the Repo Rate & Reverse Repo Rate both are increasing in
same direction. And the correlation 0.94 shows that there is Perfect Related
correlation between repo rate & reverse rate.
 4.7
relationship between
the repo rate & cash
reserve ratio
5 19/03/2010 5.75 29/01/2010 R CASH REVERSE RATIO CASH
5.75 5 28/07/2009 5 21/04/2009 E REVERSE RATIO
5 5.5 27/01/2009 5 8 P
24/10/2008 29/07/2008 8.75 7.5 O
7.75 7.75 29/01/2008 7.5 7.75 R
10/11/2007 7.5 7.75 30/10/2007 A
7 7.5 07/08/2007 7 7.25 T
31/07/2007 6.5 7 24/04/2007 E
6.5 6.5 31/01/2007 5.5 6.5
31/10/2006 5 6.25 25/07/2006 5 2
6 18/04/2006 5 6 24/01/2006 5 4/
TIME PERIOD RATES IN 1
PERCENTAGE REPO RATE 0/
2
19/03/2010 0
28/07/2009 0
27/07/2008 8
29/04/2008
29/01/2008
30/10/2007
31/07/2007
24/04/2007
31/01/2007
31/10/2006
25/07/2006
18/04/2006
24/01/2006
26/10/2005
26/07/2005
28/04/2005
4.75 4.75 27/10/2009
4.75 4.5 6.5 9
30/08/2008 9
29/04/2008 7.75 RATE
IN PERCENTAGE
29/01/2010
27/10/2009
21/04/2009
27/01/2009
TIME PERIOD

TABLE NO. 7
CORRELATION BETWEEN 0.82 Perfect
REPO & CASH RESERVE Related
RATIO Correlated

4.8
 relationship between
the REVERSE repo rate
& cash reserve ratio
19/03/2010 5.75 3.25 C3.25 29/04/2008
27/10/2009 5 3.25 AREVERSE REPO RATE
21/04/2009 27/01/2009 SREVERSE REPO RATE
4 24/10/2008 6.5 9 6 H
8.75 7.75 7.5
30/10/2007 6 7.5 R
31/07/2007 6 7 E
24/04/2007 6 7 S
31/01/2007 5.5 6.5 E
31/10/2006 5 6.5 R
25/07/2006 5 5.5 V
18/04/2006 5.5 5 E
24/01/2006 5.5 5 R
26/10/2005 5.25 5 A
26/07/2005 4.75 5 T
28/04/2005 4.75 TIME I
PERIOD RATES IN PERCENTAGE
CASH RESERVE RATIO O
29/01/2010
28/07/2009
24/10/2008
30/08/2008
29/07/2008
29/04/2008
29/01/2008
10/11/2007
30/10/2007
07/08/2007
31/07/2007
24/04/2007
31/01/2007
31/10/2006
25/07/2006
18/04/2006
24/01/2006
3.5 29/01/2010
5.75 3.25
28/07/2009 5 5
5 6 29/07/2008
6 29/01/2008 6
RATES IN
PERCENTAGE
19/03/2010
27/10/2009
21/04/2009
27/01/2009
TIME PERIOD
 TABLE NO. 8
CORRELATION BETWEEN CASH 0.6 MEDIUM
RESERVE RATIO AND REVERSE REPO 9 POSITIVELY
RATE Correlated

CHAPTER: 5
FI