1. The Reserve Bank of India (RBI) on cut the policy repo rate by 25 basis points to 6.25% in a bid to revive economic growth as it projected retail inflation to remain below its target of 4% for the next 12 months.
2. The rate reduction was the first since August 2017.
3. The RBI also simultaneously changed the stance of the policy to ‘neutral’ from ‘calibrated tightening,’ which indicates that the central bank remains ready to move in either direction based on incoming data.
4. The move will enable banks to lower their lending rates. While all six members of the monetary policy committee voted for a change in the stance, the vote for a rate cut saw two members breaking with the majority view by backing the status quo.
a. Repo rate also known as the benchmark interest rate is the rate at which the RBI lends money to the banks for a short term. When the repo rate increases, borrowing from RBI becomes more expensive. If RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate similarly, if it wants to make it cheaper for banks to borrow money it reduces the repo rate.
b. Reverse Repo rate is the short term borrowing rate at which RBI borrows money from banks. The Reserve bank uses this tool when it feels there is too much money floating in the banking system. An increase in the reverse repo rate means that the banks will get a higher rate of interest from RBI. As a result, banks prefer to lend their money to RBI which is always safe instead of lending it others (people, companies etc.) which is always risky.
c. Repo Rate signifies the rate at which liquidity is injected in the banking system by RBI, whereas Reverse Repo rate signifies the rate at which the central bank absorbs liquidity from the banks.
d. CRR – Cash Reserve Ratio – Banks in India are required to hold a certain proportion of their deposits in the form of cash. However Banks don’t hold these as cash with themselves, they deposit such cash (aka currency chests) with Reserve Bank of India, which is considered as equivalent to holding cash with themselves. This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by the RBI and is known as the CRR or Cash Reserve Ratio.
e. When a bank’s deposits increase by Rs100, and if the cash reserve ratio is 9%, the banks will have to hold Rs. 9 with RBI and the bank will be able to use only Rs 91 for investments and lending, credit purpose. Therefore, higher the ratio, the lower is the amount that banks will be able to use for lending and investment. This power of Reserve bank of India to reduce the lendable amount by increasing the CRR, makes it an instrument in the hands of a central bank through which it can control the amount that banks lend. Thus, it is a tool used by RBI to control liquidity in the banking system.
f. SLR – Statutory Liquidity Ratio – Every bank is required to maintain at the close of business every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold and un-encumbered approved securities. The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR). RBI is empowered to increase this ratio up to 40%. An increase in SLR also restricts the bank’s leverage position to pump more money into the economy.
g. Net Demand Liabilities – Bank accounts from which you can withdraw your money at any time like your savings accounts and current account.
h. Time Liabilities – Bank accounts where you cannot immediately withdraw your money but have to wait for certain period. e.g. Fixed deposit accounts.
i. Call Rate – Inter bank borrowing rate – Interest Rate paid by the banks for lending and borrowing funds with maturity period ranging from one day to 14 days. Call money market deals with extremely short-term lending between banks themselves.
j. MSF – Marginal Standing facility – It is a special window for banks to borrow from RBI against approved government securities in an emergency situation like an acute cash shortage. MSF rate is higher then Repo rate.
k. Bank Rate – This is the long term rate (Repo rate is for short term) at which central bank (RBI) lends money to other banks or financial institutions. Bank rate is not used by RBI for monetary management now. It is now same as the MSF rate. Current bank rate is 6.75%