Explained: When RBI revises rates,and what it means at the bank

Again,the inflation-versus-growth trade-off in monetary policy management,in the Indian context,has critical political overtones. Corporate India is directly and immediately hurt by the high interest rates. It therefore becomes natural for them to lobby aggressively to lower interest rates. They argue that the downside risks to economic growth associated with higher rates are much higher than corresponding inflation risks. However,monetary loosening,especially when inflationary forces are still at play and when the economy is close to breaching its potential output limit,poses significant inflation risks.

Rates and deposits

Bank rate: The RBI lends to the commercial banks through its discount window to help these banks meet depositors’ demands and reserve requirements. The interest rate that the RBI charges the banks for this is called bank rate. If the RBI wants to increase liquidity and money supply in the market,it will decrease the bank rate,and vice versa.

Repo rate: It is the rate at which the RBI lends short-term money to commercial banks. It is an instrument of monetary policy. Whenever banks have any shortage of funds they can borrow from the RBI. A reduction in the repo rate helps banks get money at a cheaper rate,and vice versa. The repo rate in India is similar to the discount rate in the US.

Reverse repo rate: It is the rate at which commercial banks park their money with the RBI. An increase in the reverse repo rate can prompt banks to park more funds with the RBI to earn higher returns on idle cash. It is also a tool that can be used by the RBI to drain excess money out of the system.

Cash reserve ratio: CRR is the cash parked by banks in their specified current account maintained with RBI. If the RBI decides to increase the CRR,the amount available with the banks comes down. The RBI uses this tool depending on whether it wants a decrease or an increase in the money supply. An increase in CRR will make it mandatory for the banks to deposit a larger proportion of their resources with the RBI. This will leave them with less to lend and in turn decrease the money supply.

Statutory liquidity ratio: Apart from CRR,banks are required to maintain liquid assets in the form of gold,cash and approved securities. A higher SLR forces them to maintain a larger proportion of their resources in liquid form and reduces their capacity to grant loans and advances; thus it is an anti-inflationary impact. A higher SLR diverts bank funds from loans and advances to investment in government and approved securities.

Open market operations: This is an important instrument of credit control through which the RBI purchases and sells securities. When inflation is up,the RBI sells securities to mop up the excess money in the market. When it has to increase money supply,the RBI buys securities.

CASA: It stands for deposits in all current and savings accounts.

So when the RBI cuts the repo rate for lending to banks,theoretically this might mean lower interest rates charged by banks on loans,but practically that might not be the case. Sometimes,even though the RBI has cut interest rates,the banks may not be able to do so. Even if they do,it might be smaller than the repo rate cut. This is primarily because banks are lending more than they are borrowing. Given that banks are finding it difficult to raise deposits to match their loans,it means they will have to continue offering high interest rates on their deposits. A high interest rate on deposits will lead to banks charging a high interest on loans as well,which translates into higher EMIs.