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IAI Actuarial Core Principles · Business Economics · Role, structure and stability of the financial system

The Reserve Bank of India wants to tighten liquidity in the banking system. Which action is consistent with this aim?

Raising the cash reserve ratio tightens liquidity. Banks must keep a larger share of deposits with the central bank, leaving less to lend, so credit creation and the money multiplier fall. The alternatives all inject reserves or cheapen borrowing, which would loosen policy.

  1. ALowering the cash reserve ratio required of banks
  2. BBuying government securities from banks in the open market
  3. CRaising the cash reserve ratio required of banksCorrect
  4. DLowering the repo rate at which it lends to banks
  5. Offering banks additional funds under a long-term repo operation at a lower rate

Explanation

A higher cash reserve ratio forces banks to hold more with the central bank, reducing funds available for lending. The other options all add liquidity or reduce the cost of borrowing from the central bank, which loosens conditions.

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