The Reserve Bank of India has various tools to control and maintain liquidity in the market. CRR and Repo rates are two of such tools.
CRR: Cash Reserve Ratio (CRR) is the ratio of deposits banks must maintain with the Reserve Bank of India. CRR determines bank interest rates
It can be explained by the below example.
- A person deposits Rs 1,000 in his/her bank account
- The bank uses the money to lend to others
- To be able to lend money the bank has to deposit a percentage of that amount with RBI.
- If CRR is 5%, the bank will deposit Rs.50 with the RBI asCRR. and has Rs.950 left at its disposal.
- The bank will lend this amount (Rs.950) to another borrower after depositing 5% of the amount (Rs.47.5) to the RBI.
- Thus Rs 1,000 will keep exchanging hands.
- Money continues to be created and available for subsequent borrowers.
- In this way Rs.1,000 is helping generate a far higher amount in the economy.
- Increase of CRR by only 1%,will result in a major reduction of the money generated in the economy
Repo Rate: The repo or repurchase rate is the interest charged by RBI to banks when they approach it for short term loans.
The repo rate is linked to the interest rate borrowers pay when they take loans from banks. The banks always charge interest which is higher than the existing repo rate from its borrowers. Lower repo rates induce lenders into lowering the interest rates they charge from individual borrowers, thereby making credit more affordable.
The RBI revises CRR and repo rates in their quarterly and mid-quarter policy reviews to maintain a balance between growth and inflation.
RBI cuts repo rate – Impact on your home loan
RBI on its fourth bi-monthly policy statement on Tuesday (29 Sept, 2015) cut the repo rate by 50 bps to 6.75% to boost Indian economy. This is the fourth repo rate cut by RBI since January 2015. After the RBI announcement, banks have started passing the benefits to their customers. Andhra bank made the first announcement and reduces the lending rate to 9.75%. SBI followed suit and cut its lending rate by 0.4% i.e. from 9.7% to 9.3%.
Reduction in Repo rate will make home loans cheaper. With rate cut, both new and existing customers will gain. The new customer will enjoy the benefit of lower interest rate as bank will pass the benefit of repo rate reduction by lowering their lending rate. For existing customers the reduced rate will translate to lower interest burden and therefore, reduction in tenure. If an existing home loan borrower is struck with high loan rate and there is another bank which is offering loan at lower interest, it is time to switch the loan account from existing bank to new bank, after considering the cost implication on transfer, foreclosure and new processing fees.
Example of How RBI’s repo rate cut will impact your financial goals
Falling interest rates benefit the most to the borrowers. RBI has cut repo rate, the rate at which it lends to the commercial banks, by 25 basis points to 7.75% with immediate effect. If the banks pass on the benefit of rate cut to borrowers, it will bring down the EMI on the floating rate home loans. For example, Anil is an IT professional who has taken a home loan of Rs 50 lakh for tenure of 20 years, He pays an EMI of Rs 51,609 at 11%. If the interest rate falls by 25 basis points to 10.75% the EMI stands reduced to Rs 50,761. As interest rates start moving down, it is the right time for Anil to approach his bank for a lower rate of interest on his home loan.
The impact of the Reserve Bank of India’s repo rate cut
Base rate reduction
A reduction in the base rate makes loans cheaper for consumers. At the same time, the incentive for people to save is reduced as fixed-deposit rates should drop as well. Lesser incentive to save will increase the spending power of the people. This will lead to a growth of the gross domestic product (or GDP) of India. Putting India’s economy back on a high-growth path is one of the key aims of the India’s present government.
In addition to increased consumer spending, Indian banks are expected to benefit due to a higher loan taking capability of the people.
More Business investment
Loans at lower interest rates should encourage corporates to invest in their businesses.
Cheap availability of credit will lead to more investments. Higher investment should help ease infrastructure investment needs.
Difference between bank rate, repo rate and reverse repo
The Bank Rate and the Repo Rate are almost the same except that Bank Rate applies to long term lending by the central bank and is governed by long term interest and inflation target. While the Repo Rate is applicable to short term lending specially for overnight lending to banks by the central bank.
Bank rate usually deals with loans, whereas, repo or repurchase rate deals with the securities. The bank rate is charged to commercial banks against the loan issued to them by central banks, whereas, repo rate is charged for repurchasing the securities
Reverse Repo Rate is used by the central bank to absorb liquidity from the economy. An increase in Reverse repo rate means that the central bank now pays more interest to the banks for depositing their money with it. The banks thus transfer 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.
SLR (Statutory Liquidity Ratio)
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 the banks need to maintain with themselves is called Statutory Liquidity Ratio.
If you deposit Rs. 100/- in a bank, and if CRR is 6% and SLR is 8%, the bank can use 100-6-8= Rs. 86/- for giving loan or for investment purpose.
Hope this answers your questions on how the repo rate affects loans. For more information, please contact us here
– Debalina Bose
Content writer- Dilzer Consultants Pvt Ltd