What is CRR, SLR, Repo Rate and Reverse Repo Rate
Reserve Bank of India (RBI) has a role to control inflation and the growth, RBI uses certain tools like CASH RESERVE RATIO, STATUTORY LIQUIDITY RATIO, REPO RATE, and REVERSE REPO RATE. These tools are maintaining certain basic ratios or maintaining certain rates.
Its primary functions is to control the supply as well as the cost of credit, Which means 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 which is nothing but liquidity and interest rates. RBI has a role to play to control these two things because eventually these two have an impact on the inflation and growth in the economy.
- To control the supply of money in the economy i.e how much money is available for the industry or the economy &amp;
- The cost of credit i.e. 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.
CASH RESERVE RATIO (CRR)
Under CASH RESERVE RATIO (CRR), a certain percentage of the total banks deposits have to be retained in the current account with RBI which means banks do not have access to that much amount for any economic activity or commercial activity. For example: – 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 result economic growth.
Statutory Liquidity Ratio (SLR)
Statutory Liquidity Ratio (SLR) is the certain percentage money that is invested (besides CRR) by banks 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.
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.
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 7 or 14 days.
RBI manages this repo rate which is the cost of credit for the bank. This becomes a floor below which the short-term interest rates don’t go. Higher the repo rate means the cost of short-term money is very high. Lower the repo rate means the cost of short-term rate is low which means at higher repo rates the economy growth may slow down whereas at lower repo rate economy growth may get enhanced.
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.
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 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.
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.
How the RBI’s rate cuts impact home Loans:-
- The RBI’s rate cuts do 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.