[Mission 2023] STATIC QUIZ, 07 March 2023 – Economy

Solution: a)

Marginal Standing Facility:

• MSF is a window for scheduled banks to borrow overnight from the RBI in an emergency situation when interbank liquidity dries up completely.
• Under interbank lending, banks lend funds to one another for a specified term.

Under MSF, banks are also allowed to use the securities that come under Statutory Liquidity Ratio (SLR) in the process of availing loans from RBI.

Solution: d)

• Liquidity Adjustment Facility (LAF) is a facility extended by RBI to the scheduled commercial banks (including RRBs which meet certain criteria) and Primary Dealers (PDs) to avail of liquidity in case of requirement or park excess funds with RBI in case of excess liquidity on an overnight basis against the collateral of G-Secs including State Development Loans (SDLs).
• Basically, LAF enables liquidity management on a day to day basis.
• The operations of LAF are conducted by way of repurchase agreements with RBI being the counter-party to all the transactions. The interest rate in LAF is fixed by RBI from time to time.
• LAF is an important tool of monetary policy and liquidity management.

Solution: a)

RBI uses various policy instruments to bring forth a healthy Reserve deposit ratio (rdr) in commercial banks. The first instrument is the Cash Reserve Ratio which specifies the fraction of their deposits that banks must keep with RBI. There is another tool called Statutory Liquidity Ratio which requires the banks to maintain a given fraction of their total demand and time deposits in the form of specified liquid assets.

A decline in CRR gives banks more cash at hand, so more lending. An increase in SLR gives less cash at hand, so less lending. An increase in repo rate makes borrowing unattractive for customers since banks now face a higher rate of funds, so less lending from banks.

Solution: a)

Capital Adequacy Ratio (CAR) is the ratio of a bank’s capital in relation to its risk-weighted assets and current liabilities. It is decided by central banks and bank regulators to prevent commercial banks from taking excess leverage and becoming insolvent in the process.

The Basel III norms stipulated a capital to risk weighted assets of 8%. So it promotes safer investments by banks that they can maintain the ratio.

So, 2 is incorrect. It has no correlation with CAR.

Solution: c)

When the interest rate is very high everyone expects it to fall in future and hence anticipates capital gains from bond-holding. Hence people convert their money into bonds. Thus, speculative demand for money is low. When the interest rate comes down, more and more people expect it to rise in the future and anticipate capital loss. Thus, they convert their bonds into money giving rise to a high speculative demand for money. Hence speculative demand for money is inversely related to the rate of interest.