Personal Finance

How RBI’s policy actions affect you

Radhika Merwin | Updated on December 22, 2012 Published on December 22, 2012

The RBI controls the credit flow by various monetary policy tools such as the repo rate, reverse repo rate and cash reserve ratio.

When repo rates are cut, banks get funds at a lower rate, which means cheaper loans.





Last Tuesday, the markets waited with bated breath to see whether the Reserve Bank of India would cut the repo rate and the cash reserve ratio (CRR). But it finally turned out to be a non-event.

The central bank did not oblige and maintained status quo on both the repo rate (at 8 per cent) and the CRR (at 4.25 per cent). So, what exactly are these rates and how do they impact the aam aadmi?

Let us first understand the fundamentals. The RBI is the nation’s banker. Its most important task is to maintain price stability, regulate the financial markets, and ensure adequate flow of credit.

The RBI controls all this by various monetary policy tools such as the repo rate, the reverse repo rate and the cash reserve ratio.

The repo rate is the rate at which the RBI lends money to commercial banks. If the RBI wants to flood funds into the system, it lowers the repo rate.

The reverse repo rate is the rate at which the RBI borrows money from commercial banks. Increasing this rate drains excess funds out of the banking system. The cash reserve ratio (CRR) is the amount of funds banks have to keep with the RBI. If the central bank increases the CRR, the amount available with the banks to lend comes down.

But why should we worry about these policies?

Increases or decreases in the repo rate impact the interest rate on loans, mortgages and deposits. How? This is where we need to understand the concept of “base rate,” that is, the minimum rate at which banks can lend.

Each bank sets its base rate depending on the cost of deposits, administrative costs, its profitability and other parameters. Loan rates are based on this. So, when the repo rate goes down, banks can obtain funds at a lower rate. This benefit may be passed on to customers, in the form of reduced interest rates on loans.

So next time experts are concerned about the RBI’s inaction on bringing down the repo rates, you must worry too.

Where does the CRR fit into all this? While loans are not directly linked to CRR, changes in the ration may impact interest rates.

When the CRR is raised, banks have to increase the funds they keep with the RBI. As the CRR earns no interest, banks may have to recoup costs through other lending.

They may also have a lower amount available to lend. This may result in interest rates going up. Remember, a CRR change does not always warrant a change in a bank’s base rate.

Hence, the RBI’s status quo on its policy this week means no change in your economics too. With expectations of a rate cut in January, that is when your pocket may get fatter.

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Published on December 22, 2012
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