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      Question

      In the context of open market operations (OMO) by the

      Reserve Bank of India, which of the following correctly describes what happens when the RBI purchases government securities from banks?
      A Liquidity is absorbed from the banking system and banks' reserves with RBI decrease Correct Answer Incorrect Answer
      B It creates a contractionary monetary policy effect reducing money supply in the economy Correct Answer Incorrect Answer
      C RBI pays banks for the securities, crediting their accounts injecting liquidity into the banking system and increasing money supply Correct Answer Incorrect Answer
      D Banks receive government securities and must hold them as SLR assets, reducing lending capacity Correct Answer Incorrect Answer
      E The yield on government securities rises as RBI buys them, making borrowing more expensive Correct Answer Incorrect Answer

      Solution

      When RBI purchases government securities from banks (OMO purchase or OMO buy), it credits the bank's current account with RBI with the purchase amount. This injects liquidity into the banking system banks now have more cash reserves that they can deploy for lending, which increases the money supply. This is an expansionary monetary action, used when the RBI wants to ease liquidity conditions. Conversely, when RBI sells government securities (OMO sell), it absorbs liquidity banks pay RBI and their reserves shrink. OMOs are a key indirect tool for managing liquidity and short-term interest rates in the economy.

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