While there was a market expectation of a 25 bps, the Reserve Bank of India(RBI) surprised the market participants by cutting the repo rate by 35 bps. This makes it the fourth consecutive cut in the repo rate.
In sceanrios like a rate cut, a lot of terms gets thrown around in newspapers but you are none the more wiser.
In this article, we will explain some of the basic financial terms associated with the central bank and how it impacts us.
Repo Rate is the rate at which both private and public sector banks such as Kotak Mahindra Bank or SBI borrow money from the Reserve Bank of India. One of the important determinats of the repo rate is the prevailing inflation rate in the economy. A low inflation rate signals that the economy is slowing down and impetus is needed to boost investment and private consumption. The current cut in the interest rate was due to the slowing economy and lack of consumption demand. The RBI tries to mantain the right balance between the inflation rate and the economic growth.
On the other hand, Reverse Repo Rate, is the rate that RBI offers to banks when they deposit their surplus cash deposits with RBI for shorter periods. If the reverse repo rate is high, banks, in a bid to earn additional interest from the RBI, will deposit more money with the RBI, thereby decreasing the cash supply or liquidity in the economy.
A low reverse repo rate means that it will be more profitable for the banks to lend money in the open market then park with the RBI. This increases the cash supply in the economy.
The current repo rate and reverse repo rates stand at 5.40% and 5.15% respectively.
CRR refers to a percentage of a certain bank’s total bank deposits. This amount is supposed to be kept with the Reserve Bank of India in the form of reserves or balances. The RBI smartly uses the CRR to control the money supply in the economy. If the CRR is high, banks will have to pledge more money with the RBI, and therefore the liquidity in the economy will be tightened. Similarly, if the CRR is low, banks will have to pledge less money with the RBI, and hence there will be a flush of liquidity in the economy. Currently, the liquidity in the economy is ample due to some of the drawdown of excess CRR.
Every financial institution is required to maintain a certain quantity of liquid assets with themselves at any specific point of time. Like CRR, this should also be in proportion to the bank’s total deposits. Generally, these liquid assets are maintained in non-cash form in instruments such as G-secs or in the form of certain precious metals. Currently, the percentage of SLR stands at 19.00%.
In simple terms, OMO is the buying and selling of government securities by the RBI, to the banks or the general public. Through open market operations, the RBI controls the liquidity in the economy. The RBI buys government securities in order to infuse liquidity in the economy. Open market operation makes bank rate policy effective and maintains stability in government securities market.
The credit ceiling defined by RBI sets the limit to which banks will be getting credit. If the credit ceiling is lowered, the banks will lower their disbursal of loans. The central bank may also direct the banks to lend to few priority sectors.
Now, you are familiar with the basic monetary policy tools and will find it easier to understand the monetary policy and make investments. You will also get better clarity on the possible impacts of the monetary policy.
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