Money, Banking, Inflation and Monetary Policy

Money

• Functions: medium of exchange, measure of value, store of value, standard of deferred payment.
• Measures of money supply:
  • M0 (reserve money): currency in circulation + bankers' deposits with the RBI + other deposits with the RBI.
  • M1 (narrow money): currency with the public + demand deposits + other deposits with the RBI.
  • M3 (broad money): M1 + time deposits. This is the most used measure.
• Money multiplier = M3 ÷ M0.
• The RBI issues currency notes (except the ₹1 note, which the government issues). Coins are minted by the government.

Reserve Bank of India

• Set up on 1 April 1935 under the RBI Act 1934, on the recommendation of the Hilton Young Commission. It was nationalised in 1949. Headquarters: Mumbai.
• Roles:
  • issuer of currency;
  • banker to the government;
  • banker's bank and lender of last resort;
  • regulator of banks and NBFCs;
  • manager of foreign exchange (FEMA, 1999);
  • payment systems.

Monetary policy

• Flexible inflation targeting (2016): the CPI target is 4% ± 2%, set by the government every five years.
• Monetary Policy Committee: 6 members; the Governor has the casting vote; it meets at least 4 times a year.
• Quantitative tools:
  • Policy repo rate: the rate at which the RBI lends to banks against government securities. A hike makes money tighter.
  • Standing Deposit Facility (SDF): the floor of the liquidity corridor.
  • Marginal Standing Facility (MSF): the ceiling.
  • CRR: cash kept with the RBI.
  • SLR: liquid assets that banks keep themselves.
  • Open market operations: buying or selling government securities.
  • Variable rate repo and reverse repo auctions.
• Qualitative tools: margin requirements, moral suasion, selective credit control.
• Transmission: loans are linked to external benchmarks such as the repo rate (2019).
• Recent stance: in 2025 the RBI cut the repo rate in several steps as inflation fell sharply. Check the latest MPC decision before your exam.

Inflation

• Types:
  • demand-pull: too much money chasing too few goods;
  • cost-push: driven by input costs, such as oil;
  • structural: supply bottlenecks, for example food.
  • Related terms:
    • stagflation: low growth with high inflation;
    • deflation: falling prices;
    • disinflation: inflation falling;
    • core inflation: excludes food and fuel;
    • headline inflation: all items;
    • skewflation: sharp rises in a few items.
• Measures:
  • CPI (NSO) is used for the target. Its base year was 2012; MoSPI planned a revised series with base year 2024 from 2026, so check which series is current.
  • WPI (base 2011–12) measures producer-level prices.
  • CPI-IW (Labour Bureau) is used for dearness allowance.
• Effects:
  • It hurts fixed-income earners and lenders.
  • It helps borrowers.
  • It hurts exports if Indian inflation is higher than in partner countries.
  • It is a regressive "tax" on the poor.
• Phillips curve: the short-run trade-off between inflation and unemployment.

Banking structure and reforms

• Scheduled commercial banks: public sector, private, foreign, Regional Rural Banks and small finance banks. Also payments banks (deposits up to ₹2 lakh, no lending) and cooperative banks.
• Nationalisation: 1969 (14 banks) and 1980 (6 banks).
  • Mergers (2017–20) reduced public sector banks to 12.
  • RRBs were consolidated to 28 ("One State One RRB", 2025).
• Committees:
  • Narasimham I (1991) and II (1998): lower CRR and SLR, prudential norms, deregulation of interest rates.
  • Nachiket Mor (2014): financial inclusion.
• Basel norms: Basel III capital adequacy. The RBI's minimum CRAR is 9% plus a 2.5% conservation buffer.
• Bad loans:
  • NPA = overdue for more than 90 days.
  • The twin balance sheet problem.
  • The Insolvency and Bankruptcy Code, 2016: resolution through the NCLT within a time limit.
  • NARCL (the "bad bank", 2021).
  • Gross NPAs of banks fell from about 11.2% (2018) to about 2.3% (2025).
• Deposit insurance (DICGC): ₹5 lakh per depositor per bank (since 2020).

Financial inclusion and digital finance

• PM Jan Dhan Yojana (2014): more than 55 crore accounts, with RuPay cards and accident cover.
• Social security schemes: PMJJBY (life insurance), PMSBY (accident) and Atal Pension Yojana.
• Mudra (2015) loan categories: Shishu, Kishore, Tarun and Tarun Plus (up to ₹20 lakh).
• Stand-Up India; SHG–bank linkage.
• Digital payments:
  • UPI (2016) handles more than 18–20 billion transactions a month.
  • The NPCI also runs RuPay, IMPS and FASTag.
  • CBDC, the e-rupee, has been piloted since 2022.
• Regulators: SEBI (securities), IRDAI (insurance), PFRDA (pensions) and the RBI.

Exam tip: Draw the "corridor": SDF at the bottom, repo in the middle, MSF at the top. Then remember that "raise rates = tighten = fight inflation". Most statement questions on monetary policy become easy once you have this picture.