Monetary policy tools: repo, reverse repo, CRR, SLR and transmission

Monetary policy works mainly by changing the cost and availability of money. Its best-known tool in India is the repo rate, the rate at which the Reserve Bank of India lends funds to banks against government securities. When the repo rate rises, borrowing becomes costlier for banks, and lending rates for households and firms tend to rise, discouraging spending and investment. When it falls, borrowing becomes cheaper, which can support demand. The reverse repo rate is the rate at which the Reserve Bank absorbs funds from banks, and it forms the lower end of the interest rate corridor in normal conditions.

Reserve requirements are a second set of tools. The cash reserve ratio, or CRR, is the share of a bank's deposits that must be held with the Reserve Bank, while the statutory liquidity ratio, or SLR, is the share that must be held in specified liquid assets, mainly government securities. Raising these ratios locks up funds that banks could otherwise lend, tightening conditions; lowering them frees funds. Open market operations, in which the Reserve Bank buys or sells government securities, add or withdraw liquidity directly. The Reserve Bank also uses standing facilities and variable-rate auctions to manage day-to-day liquidity in the money market.

Transmission is the process by which a policy rate change reaches the wider economy, and it is often slow and uneven. Banks may be slow to cut lending rates if their deposit costs are fixed, if they face bad loans, or if competition is weak. Small borrowers, informal firms and rural households may feel little effect because they borrow from non-bank or informal sources. The introduction of external-benchmark-linked lending rates for many retail and small-business loans was intended to speed transmission, but the link remains imperfect, especially for older loans and for credit that is rationed rather than priced.

Monetary policy also works through expectations and asset prices. If people believe the central bank will keep inflation low, wage and price setting become more stable, which itself helps control inflation. If credibility is lost, expectations can become unanchored and inflation harder to control. That is why central banks explain their decisions, publish minutes and forecasts, and commit to a framework. The trade-off is unavoidable: tighter policy can curb inflation but slow growth and employment, while looser policy can support growth but risk higher prices and financial excess.