Across the globe it is the government in-power which issues the currency
notes and that currency is known as the "Legal Tender" i.e. accepted by all in
that country. In India it is the role of the Central bank of the country i.e
Reserve Bank of India that prints currency notes and it bears the Governor's
signature on it.
The primary functions of RBI is:
[Link] control the supply of money in the economy i.e how much money is
available for the industry or the economy and
2. The cost of credit.' meaning, and what is the price that the economy has to
pay to borrow that money.
These two things (Supply of money and cost of credit) are closely monitored
and controlled by RBI. The inflation and growth in the economy are primarily
impacted by these two factors.
The various methods employed by the RBI to control credit creation power of
the commercial banks can be classified into two groups, viz., quantitative
controls and qualitative controls.
Quantitative controls are designed to regulate the volume of credit created by
the banking system Qualitative measures or selective methods are designed to
regulate the flow of credit in specific uses.
To control inflation and the growth, RBI uses certain tools like CASH
RESERVE RATIO, STATUTORY LIQUIDITY RATIO, REPO RATE, and
REVERSE REPO RATE
The current
CRR is 4%. If
RBI cuts CRR
in its next
monetary
policy review
then it will
mean banks
will be left
with more
money to lend or to invest. So, more money can be released into the economy
which may spur economic growth.
What is Statutory Liquidity Ratio (SLR)?
Besides CRR, Banks have to invest certain percentage of their deposits in
specified financial securities like Central Government or State Government
securities. This percentage is known as SLR.
This money is predominantly invested in government approved securities
(bonds), Gold, which mean the banks can earn some amount as 'interest' on
these investments as against CRR where they do not earn anything.
Example - An Individual deposits say Rs 1000 in bank. Then Bank receives
Rs 1000 and has to keep some percentage of it with RBI as SLR. If the
prevailing SLR is 20% then they will have to invest Rs 200 in Government
Securities
So to meet
both CRR and
SLR
requirements,
bank have to
earmark Rs
260 (Rs 60 +
Rs 200).
Higher reserve requirements such as SLR make banks relatively safe (as a
certain portion of their deposits are always redeemable) but at the same time
restrict their capacity to lend. To that extent, lowering of reserve requirement
increases the resources available with a bank to lend and helps control
inflation and propels growth.
What is Repo Rate?
When we need money, we take loans from banks. And banks charge certain
interest rate on these loans. This is called as cost of credit (the rate at which
we borrow the money).
Similarly, when banks need money they approach RBI. The rate at which
banks borrow money from the RBI by selling their surplus government
securities to RBI is known as "Repo Rate." Repo rate is short form of
Repurchase Rate. Generally, these loans are for short durations up to 2 weeks.
It simply means Repo Rate is the rate at which RBI lends money to
commercial banks against the pledge of government securities whenever the
banks are in need of funds to meet their day-to-day obligations.
Banks enter into an agreement with the RBI to repurchase the same pledged
government securities at a future date at a pre-determined price. RBI manages
this repo rate which is the cost of credit for the bank.
Example - If repo rate is 5% , and bank takes loan of Rs 1000 from RBI , they
will pay interest of Rs 50 to RBI.
So, higher the repo rate higher the cost of short-term money and vice versa.
Higher repo rate may slowdown the growth of the economy.
If the repo rate is low then banks can charge lower interest rates on the loans
taken by us.
So whenever the repo rate is cut, can we expect both the deposit rates and
lending rates of banks to come down to some extent?
This may or may not happen every time. The lending rate of banks goes down
to the existing bank borrowers only when the banks reduce their base rates
(Base Rate is the minimum rate below which Banks are not permitted to lend)
as all lending rates of banks are linked to the base rate of every bank. In the
absence of a cut in the base rate, the repo rate cut does not get automatically
transmitted to the individual bank customers. This is the reason why you
might have observed that your loan EMIsremain same even after RBI lowers
the repo rates.
Banks check various other factors (like credit to deposit ratios etc.,) before
reducing the Base rates.
What is Reverse Repo Rate?
Reverse repo rate is the rate of interest offered by RBI, when banks deposit
their surplus funds with the RBI for short periods. When banks have surplus
funds but have no lending (or) investment options, they deposit such funds
with RBI. Banks earn interest on such funds.
Current CRR, SLR, Repo and Reverse Repo Rates:
The current rates are (as of last week of December 2015) - CRR is 4 % , SLR is
21.50%, Repo Rate is 8% and Reverse Repo Rate is 7%.
RBI website has repository of all CRR, SLR & Base Rates
Impact of Repo Rate /CRR/SLR rate cut :
( A term called as "Basis Points" is often used in monetary policy reviews.
What is Basis Point? …. 1% is equivalent to 100 basis points.e.g. If Repo Rate
is 7.75% and RBI increases it by 25 basis point, then new rate will be 8% as 25
basis point will be equal to 0.25%)
Here are some points on 'how the RBI's rate cuts impact homeloans-
The RBI's rate cuts does not necessarily mean that the borrowers benefit
immediately. The landing bank has to reduce its Base Lending rate for EMI to
decrease.
These rate cuts will not have any impact on fixed rate home loans or
fixed rate consumer loans. The rate of interest is fixed with respect to fixed
loans.
The existing bank customers (who have taken loans) can see either their
Loan tenures or EMIs coming down. By default the banks reduce the loan
tenure instead of loan EMI. That means your monthly EMI installment
amount remains the same. The rate cut will make a substantial difference if
the remaining loan term/tenure is very long.
