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What is CRR, SLR, Repo Rate & Reverse Repo Rate?

What is CRR, SLR, Repo Rate & Reverse Repo Rate

What Is CRR, SLR, Repo Rate And Reverse Repo Rate?

Across the globe, currency notes are issued by their government and that currency is known as the "Legal Tender" i.e. accepted by all in that country. 

When we talk about our own country, In India it is the role of the Central Bank of our Country i.e. Reserve Bank of India that prints currency notes and circulate it in the country which have Governor's signature on it.

What are the functions of RBI?
  1. To control the supply of money in the economy i.e. how much money is available for use in our countries' economy.
  2. The cost of credit and the price that the economy has to pay to borrow that money.
The primary function of RBI is:

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 methods to control the credit creation power of the commercial banks can be classified further into two groups:
  1. Quantitative Controls - Quantitative controls are designed to regulate the volume of credit created by the banking system.
  2. Qualitative Controls - Qualitative controls are designed to regulate the flow of credit in specific uses.
Inorder to control INFLATION and GROWTH in Indian Economy, RBI uses various financial tools like CRR, SLR, REPO RATE, and REVERSE REPO RATE.

Let's elaborate all this above topics one by one:

CRR:

CRR stands for Cash Reserve Ratio.

It is the amount of funds that the banks have to keep with the RBI. If the central bank decides to increase the CRR, the available amount with the banks comes down as the amount which bank has to keep with RBI increases. 

RBI uses CRR to drain out excessive money from the economic system.

Commercial banks are required to maintain with the RBI an average cash balance, the amount of which shall not be less than 3% of the total of the Net Demand and Time Liabilities (NDTL), on a fortnightly basis and the RBI is empowered to increase the rate of CRR to such higher rate not exceeding 20% of the NDTL.
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 CRR. If the prevailing CRR is 6% then they will have to keep Rs 60 with RBI as CRR.

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.

Bank do not get any interest on this fund kept with the RBI as CRR.

SLR:

SLR stands for Statutory Liquidity Ratio.

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.

Bank earns interest on this particular fund kept with the RBI as SLR which gets invested in government bonds, securities, gold etc.

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.
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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.

Conclusion: If CRR/SLR/Repo Rates are cut down then, Deposit Rates/Lending Rates/Loan Rates may fall which results into Raise In Money Supply, Growth, Liquidity and Purchase Power.

Repo Rate

This one is very interesting banking term. When we need money, we go to bank to take loans. And bank charges certain interest rate on these loans. This is called as Cost of Credit (the rate at which we borrow the money).

Now, here an interesting question arises is... If bank need money then who will give loan to banks...???

Answer is, 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 borrow money from RBI at lower interest rates and at the same time it can charge lower interest rates on the loans taken by us (the citizen of India).

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

Do you know anything about Bank Fixed Deposits?

Your answer will be, Yes! I know about it. It is the Investment done by in bank by customer for fixed time interval on which bank pays promised fixed interest at the time of maturity.

Similarly,

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.

Now, Lets know Current CRR, SLR, Repo and Reverse Repo Rates:

The current rates (2018) are:
  • CRR = 4 % 
  • SLR = 19.5%
  • Repo Rate = 6% 
  • Reverse Repo Rate = 5.75%
  • Base Rate = 8.65% - 9.45%
Reserve Bank of India website has repository of all CRR, SLR & Base Rates.

Impact of Repo Rate/CRR/SLR Rate Cut:

A term called "Basis Points" is often used in monetary policy reviews. 

What is Basis Point? - 1% is equivalent to 100 basis points. i.e. 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 Home Loans:
  • The RBI's rate cuts does not necessarily mean that the borrowers benefit immediately. The lending 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.
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