Of the many roles to be played by it, the chief functions of Reserve Bank of India (RBI) are to regulate the economy supply (or money supply) in the financial budget also known as the cost to credit. In simple language, RBI controls the availability of money for an industry depending upon the price that is either paid or borrowed by the budget. The monetary availability is the liquidity of the borrowed money along with interest rates.
We often come across headlines such as RBI increases interest repo ratesor, RBI keeps CRR unchanged. To understand this, we should first understand what these interests are and how it affects our economy. There are two factors in this context which are carefully supervised by the RBI: the cost to credit and the money supply are the two factors which regulate the growth and inflation of the economy in our country.
To control the price rises and the progress, RBI uses technical tools like:
- Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR)
- Repo rate (RR)
- Reverse Repo rate (RRR)
Understanding CRR (Cash Reserve Ratio)
Cash Reserve Ratio is the Credits ratio which all public and private banks in India have to maintain with RBI Guidelines/ Directives. In CRR a specific proportion of the deposits (made by the banks) must be deposited to the Current account at Reserve Bank of India. This does not come with any earning for the banks. Once deposited, the banks cannot access this sum, they will not be able to use this amount for any commercial or economic activities and cannot loan this amount to any individual or company.
Here is an example: suppose, one has a deposit of rupees thousand in their bank. When the bank receives one thousand rupees, they will have to deposit a certain fraction of it to the RBI. Considering, the cash reserve is six per cent, the bank will deposit rupees sixty to the RBI and will have rupees nine hundred and forty with them. The amount of sixty rupees is not used for investment, a loan or other commercial purpose; instead, it stays in RBI’s ‘Current’ account.
If the Reserve Bank of India cuts the interest rate on CRR, then the banks will have more percentage of money which they can loan out or capitalize. Therefore, more amounts can be disbursed into the market resulting in more economic growth.
Understanding the Statutory Liquidity Ratio (SLR)
In addition to Cash Reserve Ratio, banks must invest a specific fraction of their credits in itemized financial safeties like the State Government or Central Government securities. This fraction is otherwise termed as Statutory Liquidity Ratio or SLR. This amount is mainly financed in administration securities of the Government which in turn, helps the bank in earning a good percentage of ‘interest’ on these reserves. Such benefits are not availed against a CRR.
For example, when one deposits an amount of Rs 2000 in their bank, then the bank collects Rs 2000 and must keep aside a certain percentage (SLR) with the RBI. If the predominant SLR is 20 per cent, then the bank will invest Rs 400 in Government safeties.
Understanding the Repo rate
Generally, during a monetary crisis, one always loans their desired amount from the banks with a certain rate of interest on the money loaned. This rate of borrowing the money is known as the cost to credit. Likewise, when banks have to raise loan money, RBI lends them the money. The interest rate for banks taking a loan from the Reserve Bank of India by trading their extra government safeties is known as Repo rate. Repo rate is also known as Repurchase Rate and usually, these lends are for a short duration (one to two weeks).
Repo rate is simply the interest rate at which Reserve Bank of India loans money to commercial (both public and private) banks (during their need to meet their day-to-day commitments) against their trade of Government securities
All banks come to an arrangement with the RBI to repurchase the same government securities at an upcoming date at a pre-fixed value. RBI handles the ‘Repo rate’ which is also the bank’s cost of credit.
Example: If the Repo rate is five per cent, and the bank takes an advance of rupees two thousand from RBI, they will pay an interest amount of rupees hundred to the RBI.
For your information, lower the Repo rate, lower is the cost of loaned short-term money and vice versa. Bigger Repo rate may decrease the country’s economic growth and if the Repo rate is less, then the banks can levy low-interest rates on the amount of loan given to customers.
Therefore, every time the Repo rate lowers, can we assume that both the lending rates and deposit rates of banks will reduce to some extent? This is a relative scenario. It is a two-way possibility that may or may not happen all the time.
Base rate: also known as the Basic Rate is the lowest rate under which banks are not allowed to lend. The base rates are decided by individual banks along with the bank management and it is within their rights to modify it.
The RBI has no direct control over the base rate, but it can influence the base rate through Repo rate and other tools. The banks may drop the base rate in case the RBI cuts Repo rate. With a decrease in the centrally controlled Repo rate, many banks transfer the profit to clienteles by reducing their base rates.
The base rate is not the interest rate home loans are provided. Several public sector unit (PSU) banks lend the amount at a base rate.
Understanding Reverse Repo rate:
Reverse Repo rate (RRR) is the interest rate offered by the Reserve Bank of India when public or private banks deposit their extra funds in the RBI during a shorter period. Banks that have extra funds but have no investment or borrowing options, payout such funds (also called deposits) with RBI in return for some interest that they can earn.
What are the Current SLR, CRR, Repo & Reverse Repo Rates?
The recently revised rates are:
CRR – 4%
SLR – 18.25%
Repo rate – 5.15%
Reverse Repo rate – 4.9%.