Personal Finance

How the MPC’s policy rates matter to you

Aarati Krishnan | Updated on December 05, 2020

Banker Balu’s long spell in front of the TV provoked his daughter Malathi into asking some questions.

Malathi: Dad, for God’s sake, stop watching that boring stuff and let me get to Netflix. How on earth is this speech on repo, Marginal Standing Facility, etc., useful to us!

Balu: Remember your savings account? Recall that fat education loan I took? The MPC’s decisions determine what rates you’ll earn on that deposit and what rates I’ll pay on your loan.

Malathi: Okay, if it’s about your money, I’m interested. What’s this repo and reverse repo rate thing which they’ve not changed?

Balu: The repo rate, short for repurchase rate, is the rate at which banks borrow quick money from the RBI, when they’re a little short of funds. The RBI keeps a special window called the liquidity adjustment facility (LAF) open for just this purpose.

Malathi: Don’t tell me banks run short of money and go broke!

Balu: He he! Sometimes they do, like one bank I won’t name. But we bankers often face temporary mismatches between our deposit inflows, repayments and loan outflows, which we try to plug with LAF. When we have extra money, we deposit it with the RBI at the reverse repo. Don’t you run to me to top up your account at month-ends?

Malathi: So, banks can simply walk up to the RBI and ask for money. Sounds lovely! Please open an LAF window for me, Daddy.

Balu: Sure, give me your smartphone as security. The RBI doesn’t hand out money to banks, it takes government bonds as collateral.

Malathi: Fat chance! The MPC just said that the repo rate is at 4 per cent. So, banks can borrow tonnes of money at 4 per cent and give us loans at 12 per cent? Now I know why you’re a banker.

Balu: The RBI allows banks to borrow from LAF upto a small fraction of their deposits, usually 0.25 per cent. If they need extra funds, they need to tap into the RBI’s Marginal Standing Facility, or MSF, at a higher rate.

Malathi: Why does this MPC tinker with the repo, MSF, etc? Can’t it just set them once and for all?

Balu: The MPC has to ensure that inflation doesn’t go out of control. So it regulates the price of the money - the interest rate.

When the price of money is high, there’s less of it chasing goods and services and presto, you have less inflation.

Malathi: But do repo changes affect our loans too?

Balu: Yes, your education loan is at 2 per cent over the banks’ lending rate, which is called MCLR. So, if the bank raises its MCLR, the loan becomes more expensive. But deposits will fetch me a little more, too, as my savings account rate is based on the repo rate.

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Published on December 05, 2020
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