Terms related to Credit Policy- RBI – for layman


Central banks of any country is one of the constituent to control inflation by way of adjustment of float of circulating money in the country. In India, RBI is the central bank of India. It is controlling inflation / deflation /recession etc. by using certain monetary weapons and it is supposed to be independent of Govt’s intervention. Credit policies in India are reviewed quarterly and also at adhoc dates as per necessity. Some of the key words often repeated in this connection needs some explanation for common man to understand.

  1. Statutory Liquidity Ratio (SLR) is the amount a commercial bank needs to maintain in the form of cash or gold or government-approved securities (bonds) before providing credit to its customers. The SLR rate is determined and maintained by the RBI from time to time to control the expansion of bank credit. With the SLR, the RBI can ensure solvency of a commercial bank.
  2. Cash Reserve Ratio(CRR) is a portion of deposits which banks have to keep with the RBI.Indian banks are required to hold a certain proportion of their deposits as cash. In reality they don’t hold these as cash with themselves, but with Reserve Bank of India (RBI), which is as good as holding cash. When a bank’s deposits increase by Rs100, and if the cash reserve ratio is 10, banks will hold Rs10 with the RBI and lend Rs 90. The higher this ratio, the lower is the amount that banks can lend out. Bank’s profitability suffers when CRR is increased as the lendable funds reduced. This makes the CRR an instrument in the hands of a central bank through which it can control the amount by which banks lend. CRR serves two purposes. It ensures a portion of bank deposits are totally risk-free and, second, it enables RBI to control liquidity in the system and, thereby, inflation
  3. Repo rate is the rate at which RBI lends short-term funds to banks. If the repo rate goes up, then the cost of RBI funds for banks go up. The current repo rate is 5.5 per cent.
  4. Reverse repo rate isthe rate at which RBI borrows funds from banks. An increase in reverse repo can reduce liquidity from the system, as banks find it lucrative to get high risk-free returns. The current reverse repo rate is 4 per cent.
  5. Bank rate: It is the rate at which the central banks, in india case, RBI lends to all banks on long term. AT present the rate is 6%. If it increases, automatically the lending rates of all banks will increase almost in the same lines. This is the last weapon which RBI will use in emergency to control liquidity in the market.

On 27th of this month,RBI regular review on rates is due. Already RBI has hiked the rates in the start of this month on emergency basis due to inflationery trend. The RBI hiked the repo and reverse repo rates thrice this year by 25 basis points each time. Going by the current situation, and trends in inflation and economic growth, analysts feel the RBI may decide to keep the rates unchanged, and postpone any decision to further tighten the monetary policy.

C. R. Venkata Ramani

(AICWA)

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