If you follow financial news, you must have come across the terms repo rate, reverse repo rate, crr rate, slr rate and bank rate in the past few weeks. Do you know what these terms mean and how they impact a common man?
In this article we’ll take a closer look at these terms and try to understand them from a layman’s perspective. But before that, let’s take a look at the current rates:
CURRENT REPO, REVERSE REPO, BANK RATE, CRR & SLR
|TERM||RATE (updated on 17th Nov 2013)|
|REPO RATE||7.75% (w.e.f. 29/10/2013)|
|REVERSE REPO RATE||6.75% (w.e.f. 29/10/2013)|
|BANK RATE||8.75% (w.e.f. 29/10/2013)|
|CRR||4.00% (w.e.f. 09/02/2013)|
|SLR||23.00% (w.e.f. 11/08/2012)|
Repo rate or repurchase rate is the rate at which banks borrow money from the central bank (RBI for India) for a short period by selling their securities (financial assets) to the central bank with an agreement to repurchase it at a future date at predetermined price. It is similar to borrowing money from a money-lender by selling him something, and later buying it back at a pre-fixed price.
People often get confused between Bank Rate and Repo Rate. Though they appear similar there is a fundamental difference between them.
Unlike Repo Rate, there is no sale of security in Bank Rate. Bank rate is the rate at which banks borrow money from the central bank without any sale of securities. It is generally for a longer period of time. This is similar to borrowing money from someone and paying interest on that amount.
Both these rates are determined by the central bank of the country based on the demand and supply of money in the economy.
Reverse Repo Rate
Reverse Repo rate is the rate of interest at which the central bank (RBI) borrows funds from other banks for a short duration. The banks deposit their short term excess funds with the central bank and earn interest on it.
Reverse Repo Rate is used by the central bank to absorb liquidity from the economy. When it feels that there is too much money floating in the market, it increases the reverse repo rate, which means that banks earn higher rate of interest when they deposit money with the central bank.
CRR (Cash Reserve Ratio)
Have you ever wondered what happens to the amount that you deposit in bank? It is used by banks to earn money by investing or lending it to others (house loans, personal loans etc.). But as per the regulations, banks cannot use the entire amount deposited with them for this purpose. They are required to maintain a percentage of their deposits as cash. So, if you deposit Rs. 100/- in your bank, then bank can’t use the entire Rs. 100/- for lending or investment purpose. They have to maintain a portion of the deposit as cash and can use only the remaining amount for lending/investment. This minimum percentage, which is determined by the central bank, is known as Cash Reserve Ratio.
So if CRR is 6% then it means for every Rs. 100/- deposited in the bank, it has to maintain a minimum of Rs. 6/- as cash. However, banks do not keep this cash with them, but are required to deposit it with the central bank, so that it can help them with cash at the time of need.
SLR (Statutory Liquidity Ratio)
Apart from keeping a portion of deposits with the RBI as cash, banks are also required to maintain a minimum percentage of deposits with them at the end of every business day, in the form of gold, cash, government bonds or other approved securities. This minimum percentage is called Statutory Liquidity Ratio.
If you deposit Rs. 100/- in a bank, and assuming CRR to be 6% and SLR to be 8%, the bank can use 100-6-8= Rs. 86/- for giving loan or for investment purpose.
How Is A Layman Impacted By These Rates?
Having understood the meaning of these banking terms, let us now see how we are affected by increase/decrease of these rates.
The central bank uses these rates to control inflation.
Repo Rate & Bank Rate
Banks earn profit by borrowing at a lower rate of interest from the central bank, and lending the same amount at a higher rate to the customers. If the repo rate or the bank rate is increased, bank has to pay more interest to the central bank. So in order to make a profit, banks in turn increase the interest rate at which they lend money to the customer. This dissuades the customers in taking credit from banks, leading to a shortage of money in the economy and less liquidity, thereby controlling inflation.
Reverse Repo Rate
An increase in Reverse repo rate means that the central bank now pays more interest to the banks for depositing their money with it. This results in banks transferring more funds to the central bank to earn attractive interest. As a consequence, money is drawn out of the banking system, , leading to a shortage of money in the economy and less liquidity, thereby controlling inflation.
CRR & SLR
Increase in SLR and CRR rate means that banks will have less power to give loans, which again controls amount of money floating in the market; thereby controlling inflation. It also makes banks safer to keep money because banks will have a higher liquidity to meet the demand of customers. As we learnt from the recession, giving loans expose banks to great risks. So if banks have lesser funds to give as loan, they become relatively safer.
I hope this article helped you understand the meaning of these commonly used banking terms. If you have something to add, or have some questions, feel free to use the comment form below. Share it with your friends on Facebook if you found it useful.
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