“RBI (Reserve Bank of India) has cut interest rates.”
“RBI has increased the interest rates.”
“RBI keeps the key rates unchanged..“
Have you heard or seen these kind of headlines? Hmmm, I am sure you might have….
So, what are these interest rates? How are they going to impact our finances? Let us try to understand about these interest rates in this post.
One of the primary functions of RBI is to control the supply of money in the economy and also ‘the cost of credit.’ Meaning, how much money is available for the industry or the economy and what is the price that the economy has to pay to borrow that money. ‘Availability of money’ is nothing but liquidity and ‘cost of borrowing’ is interest rates.
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.
To control inflation and the growth, RBI uses certain tools like CASH RESERVE RATIO, STATUTORY LIQUIDITY RATIO, REPO RATE, REVERSE REPO RATE etc.,
What is CRR (Cash Reserve Ratio)?
It is the ratio of Deposits which banks have to keep with RBI. Under CRR a certain percentage of the total bank deposits has to be kept in the current account with RBI. Banks don’t earn anything on that.
Banks will not have access to this amount. They cannot use this money for any of their economic or commercial activities. Banks can’t lend this portion of money to corporate or individual borrowers.
Example – You deposit say Rs 1000 in your bank. Then Bank receives Rs 1000 and has to put some percentage of it with RBI. If the prevailing CRR is 6% then they will have to deposit Rs 60 with RBI and they are left with Rs 940. Your bank can not use this Rs 60 for its commercial activities like lending or investment purpose. This Rs60 is deposited in current account with RBI.
If RBI cuts CRR then it means 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 securities which mean the banks can earn some amount as ‘interest’ on these investments as against CRR where they do not earn anything.
Example – You deposit say Rs 1000 in your bank. Then Bank receives Rs 1000 and has to put 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).
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 the central bank (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 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 verse. 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.
If RBI cuts Repo rates in its next monetary policy review which is scheduled on 2nd, December then it means the cost of short-term credit can come down.
So whenever the repo rate is cut, can we expect that 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, 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 EMIs remain same even after RBI lowers the repo rates.
Banks check various other factors (like credit to deposit ratios etc.,) before reducing the Base rates.
( Base Rate is the minimum rate below which Banks are not permitted to lend)
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 June 2018) – CRR is 4 % , SLR is 19.5%, Repo Rate is 6.25% and Reverse Repo Rate is 6%.
Impact of Repo Rate cut or CRR cut :
Currently crude oil (petrol/fuel) prices, commodity prices and inflation have eased. Against this backdrop, there is a high expectation of RATE CUT this time. So, if there is a rate cut what is the general impact on the economy?
Latest Update (01-Aug-2018) : RBI hikes Repo rate by 0.25% to 6.5%, raises inflation projection..
Latest News (06-June-2018) : RBI hikes Repo Rate by 25 bps to 6.25%; 1st Repo Rate hike since January 2014. RBI has also increased the reverse repo rate to 6%.
Latest update (07-Oct-2017) : RBI keeps all the key rates unchanged.
Latest update (02-Aug-2017) : RBI cuts Repo rate by 25 basis points. So, latest Repo rate is 6%. Reverse Repo rate has been cut by 0.25% to 5.75%.
Latest update (07-June-2017) : RBI keeps Repo rate unchanged at 6.25%, cuts SLR rate by 0.50% to 20% and also keeps Reverse repo rate and CRR unchanged at 6% & 4% respectively.
Latest News (06-April-2017) : RBI hikes Reverse repo rate by 0.25% to 6% and keeps other key rates unchanged.
(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% )
Continue reading :
- RBI cuts Repo rate : Impact on your HOME LOAN
- What if the RBI hikes interest rates? | RBI’s Rate hike – Its Impact on the Economy & Personal Finances
- What is MCLR? – Details, Components of MCLR & Review
- RBI’s latest data on Financial Savings & Liabilities of Indian Households (2016-17) | How & Where do we save & invest?
- Important Macro Economic Indicators you need to track as an Investor!