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Difficulty: HardMonetary Policy Framework, RBI Mechanisms, Banking System, and Financial Markets

With reference to the monetary policy mechanisms and liquidity management framework of the Reserve Bank of India (RBI), consider the following statements:

1. Outright purchase of Government Securities by the RBI under Open Market Operations (OMOs) injects durable liquidity into the banking system and exerts downward pressure on market bond yields.
2. The Bank Rate is aligned with the Marginal Standing Facility (MSF) rate and serves as the penal rate for commercial bank shortfalls in meeting mandatory reserve requirements.
3. Commercial banks are mandated to maintain their Statutory Liquidity Ratio (SLR) obligations exclusively in the form of unencumbered cash balances deposited with the Reserve Bank of India.

Which of the statements given above is/are correct?

  1. 1 and 2 onlyAnswer
  2. B
    1 and 3 only
  3. C
    2 and 3 only
  4. D
    1, 2, and 3

Answer

The statement combination '1 and 2 only' is correct.
The correct answer combines statements 1 and 2. Statement 1 accurately details how central bank security purchases inject liquidity and suppress interest/yield rates. Statement 2 correctly identifies the administrative linking of the Bank Rate with the MSF rate. Statement 3 is false because SLR is not restricted to cash deposits with the central bank.

Step-by-Step Solution

1
Analyze Statement 1 regarding Open Market Operations (OMOs) and bond yields.
Statement 1 is correct.
When RBI buys G-Secs, it injects cash reserves into banks. Higher demand for securities increases bond prices, which inversely lowers market bond yields.
2
Analyze Statement 2 regarding the Bank Rate and MSF relationship.
Statement 2 is correct.
Under the RBI framework, the Bank Rate is automatically aligned with the MSF rate and is utilized as a benchmark penal rate for non-compliance with reserve requirements.
3
Analyze Statement 3 regarding SLR holding requirements.
Statement 3 is incorrect.
SLR under Section 24 of the Banking Regulation Act, 1949 permits banks to hold reserves in cash, gold, or approved unencumbered securities. Only CRR (Section 42 of RBI Act, 1934) mandates cash reserves held with RBI.

Key Concept

RBI Monetary Policy Instruments: Open Market Operations, Bank Rate Alignment, and CRR vs. SLR statutory definitions
Estimated Time:2m 0s
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Topics

Monetary Policy Framework, RBI Mechanisms, Banking System, and Financial Markets