Emphasize the different money supply metrics that the RBI of India uses.
The implications of monetary policy on the risk taking behaviour of banks are: Interest Rate Influence: Lower rates reduce borrowing costs, encouraging banks to lend more, including to riskier borrowers. Higher rates increase borrowing costs, leading to more conservative lending practices. Risk andRead more
The implications of monetary policy on the risk taking behaviour of banks are:
Interest Rate Influence:
Lower rates reduce borrowing costs, encouraging banks to lend more, including to riskier borrowers.
Higher rates increase borrowing costs, leading to more conservative lending practices.
Risk and Return Trade-Off:
Low interest rates diminish returns on safe assets, prompting banks to seek higher yields through riskier investments.
High interest rates make safe assets more attractive, reducing the incentive for risk-taking.
Credit Expansion:
Expansionary monetary policy can lead to increased lending and borrowing, potentially inflating asset bubbles.
Contractionary policy typically results in reduced lending and borrowing, cooling down overheated markets.
Financial Stability:
Prolonged low interest rates may lead to excessive risk accumulation, increasing financial instability.
Higher rates can promote stability but may slow economic growth if applied too aggressively.
Regulatory Impact:
Inadequate regulatory frameworks during periods of low rates can exacerbate risky behaviour, as seen in the 2008 financial crisis.
Effective regulation is crucial to balance risk-taking and maintain financial stability under varying monetary policies.
In summary, monetary policy significantly affects banks’ risk-taking, with lower rates encouraging more risk and higher rates promoting prudence. Balancing these outcomes is essential for economical stability.
The total stock of money in circulation among the public at a particular point of time is called money supply. It consists of currency, printed notes, money in the deposit accounts and in the form of other liquid assets. It does not include other forms of wealth such as long-term investments or physRead more
The total stock of money in circulation among the public at a particular point of time is called money supply. It consists of currency, printed notes, money in the deposit accounts and in the form of other liquid assets. It does not include other forms of wealth such as long-term investments or physical assets that must be sold to convert to cash. It also does not include various forms of credit, such as loans, mortgages, and credit cards. The amount of money supply in the economy is crucial as it affects the production, price level, and employment in the economy. The central bank of the country (RBI) publishes following measures of money supply:
Reserve Money (M0): It is the base level for the money supply or the high-powered component of the money supply. It constitutes currency in circulation, Bankers’ deposits with the RBI and ‘other’ deposits with the RBI.
Narrow Money: It typically covers the most liquid form of money that can be easily converted into currency or used for cashless payments for transaction and commerce purposes. RBI publishes M1 and M2 as the two measures of narrow money:
M1: It consists of currency (notes plus coins) held by public and net Demand deposits held with the commercial banks and ‘other’ deposits with the RBI. This is the most liquid and easiest money available for transactions.
M2: It consists of M1 plus Savings deposits with the Post Office Saving banks.
Broad Money: It is a broad classification of money that includes time deposits along with currency in circulation and demand deposits with banks and post offices. They are less liquid than the narrow money. RBI publishes:
M3: It consists of M1 plus net time deposits of commercial banks. It captures the complete balance sheet of the banking sector and is known as aggregate monetary resources. It is the most common measure used for money supply.
M4: M3 plus all deposits with the post office saving banks (excluding National Savings Certificates). Since total deposits with post offices are negligible, there is not much difference between M3 and M4.
In terms of liquidity, these can be arranged as- M1>M2>M3>M4. ‘Other’ deposits with RBI comprise mainly: (i) deposits of quasi-government and other financial institutions including primary dealers, (ii) balances in the accounts of foreign Central banks and Governments, (iii) accounts of international agencies such as the International Monetary Fund, etc. Valuation and analysis of the money supply in the economy helps the policy makers to frame or to alter the monetary policy.
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