UNDERSTAND WHAT ARE CRR, REPO RATE, REVERSE REPO RATE, BANK RATE ETC.

What is Bank Rate ?  This is the rate at which central bank (RBI)  lends money to other banks or financial institutions.   If the bank rate goes up, long-term interest rates also tend to move up, and vice-versa. Thus, it can said that in case bank rate  is hiked,  in all likelihood banks will hikes their own lending rates to ensure that they continue to make profit.

What is CRR?  CRR means Cash Reserve Ratio.  Banks in India are required to hold a certain proportion of their deposits in the form of  cash.  However, actually Banks  don’t hold these as cash with themselves, but deposit such case with Reserve Bank of India (RBI) / currency chests, which is considered as  equivalent to holding cash with RBI. This minimum ratio (that is the part of the total deposit  to be held as cash) is stipulated by the RBI and is known as the CRR or  Cash Reserve Ratio.  Thus, When a bank’s deposit increase by Rs100, and if the cash reserve ratio is 6%, the banks will have to hold additional Rs 6 with  RBI and Bank will be able to use only Rs 94 for investments and lending / credit purpose. Therefore,  higher the  ratio (i.e. CRR), the lower is the amount that banks will be able to  use for lending and investment.  This power of RBI to reduce the lendable amount by increasing the CRR,  makes it an instrument in the hands of a central bank through which it can control the amount that banks lend.  Thus, it is a tool used by RBI to control liquidity in the banking system.

What are Repo rate and Reverse Repo rate?

Repo (Repurchase) rate is the rate at which the RBI lends shot-term money to the banks against securities. When the repo rate increases borrowing from RBI becomes more expensive.  Therefore, we can say that in case,  RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

Reverse Repo rate is the rate at which banks park their short-term excess liquidity with the RBI.  The banks use this tool when they feel that they are stuck with excess funds and are not able to invest anywhere for reasonable returns.     An increase in the reverse repo rate  means that the RBI is ready to borrow money from the banks at a higher rate  of interest. As a result, banks would prefer to keep more and more surplus funds with RBI.

What is SLR?  SLR means Statutory Liquidity Ratio. It means such ratio of liquidity which has been made mandatory for the banks by a statute.  Every bank is required to maintain at the close of business every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold and un-encumbered approved securities. The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR).  RBI is empowered to increase this ratio up to 40%.  An increase in SLR  also restrict the bank’s leverage position to pump more money into the economy.