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Key policy rates used by RBI to influence interest rates
The key policy or 'signalling' rates include bank rate, the repo rate, the reverse repo rate, cash reserve ratio and statutory liquidity ratio.
RBI increases its key policy rates when there is greater volume of money in the economy. In other words, when too much money is chasing the same or lesser quantity of goods and services.
Conversely, when there is a liquidity crunch or recession, RBI would lower its key policy rates to inject more money into economic system.
What is repo rate?
Repo rate, or repurchase rate, is the rate at which RBI lends to banks for short periods. This is done by RBI buying government bonds from banks with an agreement to sell them back at a fixed rate.
If the RBI wants to make it more expensive for 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.
The current repo rate is 5.50%.
What is reverse repo rate?
Reverse repo rate is the rate of interest at which the RBI borrows funds from other banks in the short term.
Like the repo, this is done by RBI selling government bonds to banks with the commitment to buy them back at a future date.
The banks use the reverse repo facility to deposit their short-term excess funds with the RBI and earn interest on it.
RBI can reduce liquidity in the banking system by increasing the rate at which it borrows from banks. Hiking the repo and reverse repo rate ends up reducing the liquidity and pushes up interest rates.
What is Cash Reserve ratio (CRR)?
Cash reserve Ratio (CRR) is the amount of funds that banks have to park with RBI. If RBI decides to increase the cash reserve ratio, the available amount with banks would reduce. The bank increases CRR to impound surplus liquidity.
CRR serves two purposes: One, it ensures that a portion of bank deposits are always available to meet withdrawal demand, and secondly, it enables that RBI control liquidity in the system, and thereby, inflation by tying their hands in lending money.
The current CRR is 6%.
What is SLR? (Statutory Liquidity Ratio)
Apart from keeping a portion of deposits with RBI as cash, 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 is called Statutory Liquidity Ratio.
In times of high growth, an increase in SLR requirement reduces lendable resources of banks and pushes up interest rates.
The current SLR is 25%.
What is the bank rate?
Unlike other policy rates, the bank rate is purely a signalling rate and most interest rates are de-linked from the bank rate. Also, the bank rate is the indicative rate at which RBI lends money to other banks (or financial institutions) the bank rate signals the central bank's long-term outlook on interest rates.
If the bank rate moves up, long-term interest rates also tend to move up, and vice-versa.
(Posted date - 06 July 2010)