Repo Rate
The Repo Rate is the interest rate at which a country’s central bank lends money to commercial banks when there is a cash shortage. The Repo Rate is used by monetary authorities (such as the Reserve Bank of India) to curb inflation.
When inflation occurs, central banks raise the Repo Rate to deter banks from borrowing from them. As a result, the supply of money in the economy is lowered, which aids in controlling inflation. If inflationary pressures fall, the central bank takes the opposite attitude. Repo Rates and Reverse Repo Rates are part of the liquidity adjustment facility. India’s central bank, The Reserve Bank of India (RBI), uses Repo Rates to control liquidity in the economy.
Repo rate is associated with the ‘repurchase option’ or ‘repurchase agreement’ in banking. When there is a lack of cash, commercial banks borrow money from the central bank, returned at the applicable Repo Rate.
The central bank offers these short-term loans in exchange for assets like treasury bills or government bonds. The central bank employs this monetary strategy to reduce inflation or enhance bank liquidity. When the government needs to regulate prices and limit borrowings, it raises the Repo Rate.
On the other hand, the Repo Rate decreases when there is a need to introduce more money into the market to encourage economic development. An increase in the Repo Rate implies commercial banks must pay higher interest on cash given to them, and so a change in the Repo Rate impacts public borrowings like house loans and EMIs. The Repo Rate influences many financial and investment instruments, from interest rates imposed by commercial banks on loans to deposit returns.
Reverse Repo Rate
The interest rate at which a country’s central bank pays its commercial banks to store surplus cash with the central bank. The Reverse Repo Rate is also a monetary policy adopted by the central bank (in India, the RBI) to control the flow of funds in the market.
When a country’s central bank requires funds, it borrows from commercial banks and pays them interest at the prevailing Reverse Repo Rate. At any given moment, the RBI’s reverse repo rate usually is lower than the Repo Rate. While the Repo Rate is intended to regulate liquidity in the economy, the Reverse Repo Rate is used to control market cash flow.
When the economy experiences inflation, the RBI raises the Reverse Repo Rate to encourage commercial banks to make deposits with the central bank and earn returns. This, in turn, drains surplus funds from the market and limits the amount of money available for public borrowing.
Bank Rate
The Bank Rate (Discount Rate) is the rate at which the Reserve Bank of India offers long-term loans to the banks.
Like the Reserve Bank of India, the central bank practices the Bank Rate to manage and control the credit scenario of the country, leading to a betterment of the national economy and the banking sector.
The Bank Rate directly affects the rate of interest on the loans offered by commercial banks.
If the Bank Rate is higher, then the lending rate of commercial banks is increased as the bank tends to make profits by borrowing funds at a low rate and lending funds at a high rate.
Statutory Liquidity Ratio
The Statutory Liquidity Ratio (SLR) is the minimum percentage of deposits that commercial banks must keep in liquid assets such as cash, gold, government securities, etc. SLR is a portion of the bank’s Net Demand and Time Liabilities (NDTL), or demand deposits and time-based deposits.
The country’s central bank sets the SLR limit for commercial banks (the Reserve Bank of India or RBI in India), although the banks themselves hold deposits. The SLR, on the other hand, cannot be used by the bank for loans. Deposits allocated for SLR can receive interest. The RBI’s monetary policy is intended to guarantee bank solvency or ensure that banks can repay their creditors at any point in time. This ensures that the depositor’s money is secure and helps in increasing their trust in the bank.
SLR is used to control inflation and keep the economy running smoothly. When there is inflation, the RBI raises the SLR to limit the bank’s lending ability. When there is a need to inject capital into the system, the RBI lowers the SLR to assist banks in offering loans at lower interest rates and improving borrowings.
Cash Reserve Ratio
The Cash Reserve Ratio (CRR) is a percentage of a commercial bank’s total deposits that must be kept with the country’s central bank (which is the RBI in India). The limit of CRR must be maintained, which the RBI decides. The deposit, however, is in the form of liquid cash and must be stored in an account with the RBI.
Banks are not authorized to use CRR deposits to make loans or other lending purposes. Aside from that, CRR deposits are not eligible to earn interest. CRR contributes to the bank always having adequate cash to distribute when depositors want it. This monetary strategy aims to keep the economy’s inflation under control. When the CRR is raised, commercial bank’s cash reserves are decreased, limiting their lending potential. This reduces borrowing and aids in the management of inflation.