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Monetary policy tools: practice questions for bank exams
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Monetary policy is how the Reserve Bank of India (RBI) controls the supply and cost of money in the economy. The tools are standard banking awareness: repo rate, CRR, SLR, the standing facilities and open market operations. The IBPS PO mains General/Economy/Banking Awareness section has 50 questions for 60 marks in 35 minutes, and it includes RBI circulars (see the IBPS PO exam pattern), so the concepts here are worth knowing well. RBI Grade B Phase II also covers the RBI's role. This page covers concepts only, because rates change; check current figures on the RBI website.
Who decides and what the tools are
In India the policy repo rate is decided by the Monetary Policy Committee (MPC), a six-member body set up under the RBI Act. The RBI Governor chairs it, and the Governor has a casting vote if the votes are tied. The Government of India sets the inflation target in consultation with the RBI, and the MPC sets the policy rate to meet it.
| Tool | What it is | Effect on money in the system |
|---|---|---|
| Repo rate | The rate at which the RBI lends short-term to banks against government securities, with an agreement to repurchase | A higher rate makes funds dearer for banks |
| Standing Deposit Facility (SDF) | Banks park surplus funds with the RBI without giving collateral; it sets the floor of the rate corridor | Absorbs liquidity |
| Marginal Standing Facility (MSF) | Banks borrow overnight against government securities at a rate above the repo rate; it sets the ceiling of the corridor | Provides emergency liquidity |
| Cash Reserve Ratio (CRR) | The share of net demand and time liabilities (NDTL) that banks keep as cash with the RBI, earning no interest | Raising it reduces lendable funds |
| Statutory Liquidity Ratio (SLR) | The share of NDTL that banks hold in cash, gold or approved securities themselves | Raising it reduces lendable funds |
| Open market operations (OMO) | The RBI buys or sells government securities | Buying adds liquidity, selling removes it |
| Bank rate | The long-standing rate at which the RBI lends to banks; it is now aligned with the MSF rate | A signal of the policy stance |
Five practice questions
Question 1
The Cash Reserve Ratio is the share of a bank's net demand and time liabilities (NDTL) that must be kept:
- A. As cash with the RBI
- B. As government securities with the bank
- C. As gold with the bank
- D. As deposits with other commercial banks
Question 2
Which statement about the Statutory Liquidity Ratio (SLR) is correct?
- A. Banks must keep it only as cash with the RBI
- B. Banks may hold it as cash, gold or approved securities themselves
- C. It is a loan from the RBI to the banks
- D. It is a tax on bank deposits
Question 3
If the RBI sells government securities in the open market, the immediate effect is to:
- A. Increase liquidity in the banking system
- B. Raise the CRR
- C. Reduce liquidity in the banking system
- D. Lower the repo rate
Question 4
Under the Marginal Standing Facility (MSF), banks can borrow overnight from the RBI against:
- A. Gold jewellery only
- B. Unsecured promissory notes
- C. Foreign currency deposits
- D. Government securities, including by dipping into their SLR holdings
Question 5
Other things being equal, a rise in the repo rate generally leads to:
- A. Costlier borrowing for banks and upward pressure on lending rates
- B. Cheaper loans for customers
- C. A fall in the SLR
- D. No effect on lending rates
Answers and explanations
- A. CRR is kept as cash balances with the RBI, and the RBI pays no interest on it. Option B describes SLR.
- B. SLR is held by banks themselves in liquid assets such as cash, gold and approved government securities, not as a deposit with the RBI. It is not a loan or a tax.
- C. When the RBI sells securities, banks pay the RBI for them, so money moves out of the banking system. Buying securities does the opposite.
- D. MSF lets banks borrow overnight against government securities, and they can use the securities from their SLR holdings up to a stated limit. The other options are not eligible collateral.
- A. A higher repo rate raises the cost of funds for banks, and loans linked to the repo rate become more expensive, which also tends to cool demand and inflation.
How to prepare monetary policy
- Learn the corridor. The MSF rate is the ceiling, the SDF rate is the floor and the repo rate sits between. Draw it as a three-line diagram and check the latest spreads in the RBI's policy statement.
- Think in terms of liquidity. For each tool, ask whether it adds or removes money from the system.
- Do not memorise rates. They change, so learn what each tool does when it rises or falls.
- Connect to lending. Loans for retail and MSME borrowers are linked to an external benchmark, often the repo rate, so a change passes through to borrowers' instalments.
- Revise terms in pairs. Keep CRR against SLR, and repo against SDF, in one table to avoid confusion.
The full monetary policy topic test is on PrepMatic (about 15 questions, 30 minutes). The banking awareness guide lists the wider syllabus, and the bank exam hub links each exam's pattern.
Source
- Reserve Bank of India: policy statements, press releases and the list of current rates. Check the latest release before an exam.
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