Monetary Policy Rates

By Banking_awareness 1 years ago
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Monetary policy is the process by which monetary authority of a country , generally central bank controls the supply of money in the economy.It is concerned with deciding how much money the economy should have.It is so designed as to maintain the price stability in the economy.In India, the central monetary authority is the Reserve Bank of India (RBI).

Instruments of Monetary policy :

These instruments are used to control the liquidity in the economy :

Cash Reserve Ratio (CRR) :-

CRR is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances. Higher the CRR with the RBI lower will be the liquidity in the system and vice versa.                                                                                                                                             Let's take an example ,Common men save their money in bank. Bank gives them say 8% interest rate on savings. Then Bank gives that money as loan to businessmen and charges 14% interest rate. So 14-8=6% is the profit of Bank. Although that’s technically incorrect, because we’ve not counted bank’s input cost-staff salary, telephone-internet-electricity bill, office rent, xerox machine etc. So actual profit will be less than 6%.                                                                             Now let's assume SBI has only one branch in a small town.Total 100 common men deposited 1 lakh each in their savings accounts  so total deposit is 1 crore and SBI offered them 8% interest rate per year on their savings . SBI Branch manager gives away entire 1 crore to a businessman as loan for 14% interest rate for 5 years.Its good for SBI. But on the next day some of those common men will need to take out some money from their banks savings account- to pay for electricity, mobile bills, college fees, writing cheques and demand drafts etc.But SBI’s office doesn’t have money .So Banks must not give away all of the deposit money to businessmen for loans. Banks must keep some money with aside. This is called CRR.

Statutory Liquidity Ratio (SLR) :-

SLR is the amount a commercial bank needs to maintain in the form of gold or government approved securities (bonds)  before providing credit to its customers . It is determined as the percentage of total Net Demand and Time Liabilities .                                                             
                       Let's continue the same example .SBI has Rs.1 crore.Suppose SBI must keep Rs. 10 lakhs as CRR. Now SBI  is left with 90 lakhs rupees . So SBI manager decides to get maximum profit out of remaining money. Suppose ongoing rate for business loans is 12%. But there is one businessman Mr.Verma. No bank is offering him loan, because his past track record is not good: his earlier business adventures were epic fail. This Mr.Verma comes to SBI and Tell -
                 "give me all of those 90 lakh rupees as loans, I’m ready to pay 36% interest rate on it! And trust me, I’m going to make lot of money in my new business project. And I’m ready to mortgage all of my factories, cars, farmhouses. So if I can’t repay loan, you can auction them and recover your money". 
                       SBI gives him 90 lakhs as loan.After six months, Mr. Verma’s new business project also fails. He cannot pay back the EMIs. Although SBI can attach his assets and auction them to recover the money. But it’ll take lot of time.In the mean time some common men need their money .Bank must not give away all its loans to risky loan takers. Banks must invest part of its money in “safe and liquid” investment. So during emergency, bank can sell those “liquid” investments and take out the money.For example, Government securities, gold, corporate bonds of reputed companies like Infosys, reliance, TCS. These are “safe” investments. These are also “liquid”, because you can sell them quickly whenever you want. This is called SLR. SBI could also auction Mr.Verma’s properties, but it’ll take lot of time in paperwork, legal issues etc.

Repo Rate :-

Repo rate is the rate of interest which is levied on "short term" loans taken by commercial banks from RBI.Whenever the banks have any shortage of funds they can borrow it from RBI . For example when SBI wants to borrow money from RBI for short term, SBI will have to pay xyz interest rate. 
                          RBI has cash of Rs.100 lakhs. SBI has Government securities worth Rs.100 lakhs. SBI enters into Repo agreement with RBI. The agreement reads  "I (SBI) am selling my Government securities worth Rs.100 lakh to RBI and I (SBI) promise to buy back (repurchase) those securities from RBI after 6 months @Rs.107 lakhs". 
 Now : Time: after 6 months. RBI’s investment: Rs.100 lakhs After 6 months, RBI gets: Rs.107 lakhs from SBI. So profit of RBI (or interest earned by RBI or interest paid by SBI)=(107-100)/100 = 7%. This is Repo rate.

Reverse Repo Rate :-

This is exact opposite to Repo rate . Reverse Repo Rate is the rate at which RBI borrows money from the commercial banks for short term . RBI uses this tool when it feels there is too much money floating in the banking system .

Bank Rate

Bank Rate is the rate of interest which charges by RBI on  its clients for "long term" loans. 


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