Mr. Rawat while reading a newspaper came across a news item on the repo rate cut, CRR, base rate, SLR, and reverse repo rate. He was curious to know about these terms. We often come across such terms but may not be aware of how are they going to impact our finances. So, let’s try to understand about these interest rates in this article.
The 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 things. In this context, RBI uses certain tools like cash reserve ratio, statutory liquidity ratio, repo rate, reverse repo rate etc., to control the money supply in the economy.
What Is Repo Rate
Repo rate is better known as repurchase rate. This is the interest rate at which the RBI lends money to commercial banks, in case of shortage of funds. When the RBI increases the repo rate, it becomes more expensive for banks to lend money from the central bank. Thus the home loan interest rate increases. When the RBI slashes the repo rate, it helps banks get money at a cheaper rate and vice versa. Whenever banks face a shortage of funds, they can borrow from the RBI as per the repo rate. Generally, these loans are for short durations (up to 2 weeks). The current repo rate is 5.15%.
What Is Reverse Repo Rate
Reverse repo as the name suggests is an opposite contract to the Repo Rate. Reverse Repo rate is the rate at which the Reserve Bank of India borrows funds from the commercial banks in the country. Also, whenever banks have surplus funds in hand, which they are not keen on investment or lending, they deposit such funds with RBI usually for a short-term. Based on the reverse repo rate, banks earn interest on such funds. It is also a tool used by the RBI to clear excess money out of the banking system. When the reverse repo rate rises, banks may increase home loan interest rates, since it becomes more profitable for commercial banks to invest the extra money in low-risk government securities instead of lending to people investing in property in India. When the reverse repo rate falls, so does the home loan interest rates. Current Reverse Repo Rate is 4.90%.
What Is Cash Reserve Ratio (CRR):
The full form of CRR is Cash Reserve Ratio. This term is used to define the amount of funds that the banks in India are supposed to maintain with the RBI at all times. Every bank in India has a current account with the RBI. Under CRR, a certain percentage of the total bank deposits has to be kept in the current account with RBI. Banks cannot use this money for any of their economic or commercial activities. CRR is an instrument the RBI uses to drain out excessive money from the system. The deposits in this account are governed by the current CRR rate, which at present is 4%.
What Is Statutory Liquidity Ratio (SLR):
Apart from CRR, banks are also required to invest certain percentage of their deposits in certain specified securities predominantly Central Government and State Government securities. This percentage is known as SLR rate or Statutory Liquidity Ratio rate. The funds can be in the form of government approved securities (bonds), or precious metals,, which mean the banks can earn some amount as 'interest' on these investments. When the SLR is high, then the banks have less money for commercial operations and hence less money to lend out. When the SLR is low, similarly, home loan interest rates are likely to fall. The current SLR is set at 19.5% per annum.
What Is Base Rate:
The base rate is the minimum rate of interest that is set by the Reserve Bank of India for lending a loan. This rate is usually taken as the standard interest rate by all the banks functioning in India. Once the base rate is determined by the RBI, no bank is permitted to offer any type of loan to its customers at a rate that is lower than the base rate that has been set by the Reserve Bank of India.