Skip to content
FreeFinance

Financial institutions and monetary policy

What does a bank actually do, and how does a decision in Mumbai reach your loan?

12 of 12 chapters published

Chapters

Beginner

  1. What a bank actually doesA bank borrows short and lends long, and that mismatch is not a flaw in the design — it is the business. Understanding it explains both why banks are useful and why they fail the way they do.
  2. How deposits become loansBanks do not lend out deposits the way a warehouse lends out grain. Lending creates a deposit, and seeing that correctly changes what you think constrains the amount of credit in an economy.
  3. Bank capital, and why it is regulatedCapital is the buffer between a bank's losses and its depositors. Too little and the public bears the failure; too much and lending becomes expensive — which is why the number is set by regulation rather than by the bank.
  4. NPAs and provisioningWhen a loan stops performing, the RBI's rules decide when the bank must admit it. The ninety-day line exists because without a hard rule, the admission arrives whenever it is convenient.

Intermediate

  1. The RBI's mandateOne institution does several jobs that pull against each other, and since 2016 the first of them has had a statutory target and a committee that votes on it.
  2. The policy rate and the corridorThe repo rate is announced, but what actually anchors overnight money is a corridor with a floor and a ceiling. The structure explains why a rate cut sometimes does nothing.
  3. How a rate change reaches your loanThe gap between a decision in Mumbai and the EMI on your home loan is called transmission, and it was slow and asymmetric for long enough that the rules were rewritten to force it.
  4. Open market operations and liquiditySetting a rate is not enough; the central bank must also manage how much cash the system is carrying, because that decides where inside the corridor the rate actually sits.

Advanced

  1. Inflation targeting in IndiaTargeting a consumer price index in an economy where food and fuel swing violently, with a tool that works on demand. The design choices follow from that tension, and so do the criticisms.
  2. The money supplyMost money is not printed. It is a bank deposit created by lending, which is why the central bank influences the quantity of money indirectly and cannot simply set it.
  3. NBFCs and shadow bankingInstitutions that lend like banks without being banks. They reach borrowers banks will not, and they carry the same maturity mismatch with none of the deposit insurance or the lender of last resort behind it.
  4. When a financial system breaksFailures rhyme. Credit expands against rising collateral, a shock arrives, liquidity and solvency become indistinguishable, and the authorities face a choice with no good option.