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Understanding RBI Policy and different rates : Part 1
Economy

Hello Friends. We hope you all are having an excellent time learning and earning in the Market. On June 7, 2016, came the news that Reserve Bank of India has left the Repo Rate unchanged at 6.5 percent in its Second Bi-monthly Monetary Policy. When we flashed this news on our News Section “Trending News”, many of you wanted to understand what Repo Rate is. So today in TradeTalk we will learn not only about the Repo Rate, but also understand what is RBI Policy and several other rates and terms used in it.

Since this is an extensive topic and I would like to explain it in detail for your better understanding, I will discuss this topic in two blogs.

Before we jump straightaway to the RBI Policy Review, let’s understand what RBI is.

Reserve Bank of India or RBI

The Reserve Bank of India is the primary and central bank of India, which was established on April 1, 1935, under the Reserve Bank of India Act. The Reserve Bank of India uses its monetary policy to create financial stability in India, and is responsible for regulating the country’s currency and credit systems.

Monetary Policy

Monetary policy is an RBI Policy or process by which RBI controls the supply of money in the economy by its control over interest rates in order to maintain price stability and achieve high economic growth. Monitory Policy helps to maintain the price stability in the India.

RBI publishes its Monitory Policy Review every month after closely monitoring the macro-economic factors like Inflation, growth in India and outside India, liquidity of banks and key International events like Monetary Policy review of US done by Fed. Based on the observations, RBI makes revision of key rates if required.

Repo Rate

Repo rate is an interest rate at which commercial banks borrow money from RBI. Since the prevailing repo rate is 6.5%, this means RBI is lending money to the Banks at an interest of 6.5% annually.

Any Increase in Repo rate suggest that the banks will have to pay higher interest to RBI. If banks have to pay higher interest to RBI, this means Banks will also increase interest rates when they give loans to individuals or companies.

Reverse Repo Rate

This is the rate of interest at which RBI borrows money from the Banks. This is opposite of Repo Rate. If RBI increases the Reverse Repo Rate, this means RBI will want to borrow the money at a higher rate from the banks. This will make banks more interested in giving money to the RBI instead of giving it the consumers thereby reducing the liquidity in the market. Current Reverse Repo Rate in India is 6 %

Cash Reserve Ratio or CRR

CRR is a minimum percentage of cash deposits that banks compulsorily have to keep with RBI.

Current CRR is 4%. This means for a cash deposit of 100, the banks will have to park Rs 4 with RBI.

RBI uses CRR either to suck excess liquidity from the system or to release funds needed for the growth of the economy. Increase in CRR means that banks have less money available which means lower liquidity in the system.

Statutory Liquidity Ratio or SLR

SLR is a percentage bank deposits that banks will have to compulsorily invest in government bonds. The banks may invest in form of gold, cash or other approved securities.  Thus, we can infer that it is a ratio of cash and some other approved securities to liabilities (deposits)

SLR helps in regulating the credit growth in India

RBI may increase SLR upto 40%.  An increase in SLR also restrict the bank’s leverage position to push in more money into the economy.

Current SLR is 21.25%

Basis Points

A Basis Point is one hundredth of one percentage point. 1% is equivalent to 100 basis points.

Example : Current Repo Rate is 6.5 % . If RBI decides to decrease this by 25 basis point, this means new Repo Rate will be 6.25 %. 25 basis points will be equal to 0.25%.

I hope that you are clear with the concept. Here, I will finish Part 1 of “Understanding RBI Policy and different rates”. Will publish part 2 of this blog next week, which will be really interesting. So Do not miss it. Till then keep your questions and doubts flowing in.

Happy Investing

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Pratyush is a Post Graduate in Marketing Management and has a leadership experience of nearly a decade in diversified industry including Stock Broking. Having headed companies for over half a decade, Pratyush brings with him, rich Marketing and....

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