Central banking plays a pivotal role in maintaining monetary stability, ensuring financial system soundness, and guiding a nation’s economy. To understand the framework of central banking and its policies, it is useful to be familiar with commonly used terminology. This glossary provides concise explanations of key central banking terms, especially relevant for the Indian context, while maintaining universal applicability.
Monetary Policy
The framework through which a central bank manages money supply and interest rates in order to achieve macroeconomic objectives such as inflation control, growth, and financial stability.
Repo Rate
The rate at which the central bank lends short-term funds to commercial banks against securities. This acts as a key signaling rate for monetary policy transmission.
Reverse Repo Rate
The rate at which commercial banks can park their surplus funds with the central bank. It is used as a liquidity absorption tool.
Cash Reserve Ratio (CRR)
The portion of a commercial bank’s net demand and time liabilities (NDTL) that must be maintained as cash with the central bank. This controls liquidity in the system.
Statutory Liquidity Ratio (SLR)
The minimum percentage of commercial banks’ NDTL that must be invested in government securities and approved assets before offering credit to customers.
Open Market Operations (OMO)
The buying and selling of government securities by the central bank in the open market to regulate liquidity conditions.
Liquidity Adjustment Facility (LAF)
A mechanism introduced by the central bank to facilitate daily liquidity operations through repo and reverse repo auctions.
Marginal Standing Facility (MSF)
A window under which scheduled banks can borrow overnight funds from the central bank against approved government securities, usually at a penal rate.
Bank Rate
The rate at which the central bank provides long-term loans to commercial banks. Unlike the repo rate, it is not tied strictly to short-term liquidity management.
Monetary Transmission
The process through which changes in the central bank’s policy rates influence commercial banks’ lending and deposit rates, ultimately affecting aggregate demand and inflation.
Inflation Targeting
A monetary policy approach where the central bank explicitly sets and pursues an inflation target to ensure price stability while supporting economic growth.
Quantitative Easing (QE)
An unconventional monetary policy tool where the central bank purchases financial assets, primarily government bonds, to inject liquidity when standard tools are insufficient.
Standing Deposit Facility (SDF)
A tool introduced by central banks (including RBI) to absorb liquidity without collateral, providing flexibility in liquidity management.
Moral Suasion
The use of persuasion or guidance by the central bank to influence banking sector operations without direct regulatory action.
Lender of Last Resort
The role of the central bank in providing emergency liquidity support to financial institutions facing crises, ensuring systemic stability.
Capital Adequacy Ratio (CAR)
A measure of a bank’s capital in relation to its risk-weighted assets, ensuring resilience against financial shocks.
Prudential Norms
Regulatory standards prescribed by the central bank regarding income recognition, asset classification, provisioning, and exposure limits to maintain financial discipline.
Financial Stability
A condition where the financial system functions efficiently without disruptions, even in the face of shocks, safeguarded by central bank oversight.
Payment and Settlement Systems
Infrastructure overseen by the central bank that enables safe transfer and settlement of funds and securities, critical for the smooth functioning of the economy.
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