MONETARY POLICY RATES

Hey hey hey hello my dear friends, how are you all?

Today I am going to explain Monetary Policy Rates in a very simple language. Whenever we read topics we only read it and never try to go in depth. According to me if we are reading something then we’ll have to ask some questions about that particular topic WHAT, WHEN, WHY, HOW & BY WHOM. I mean to say ask yourself: (What is this? When, why and how this happened and by whom? ) then you will become master of that particular topic.

We all know the definitions of Bank Rate, Repo Rate, Reverse Repo Rate, Cash Reserve Ratio (CRR) and Statutory Liquidity ratio (SLR) but many of you perhaps doesn’t know why banks maintain these rates and what is the need to maintain them.

1) What does bank do with our money?

Basically banks lend out our money at high interest rates to earn money. Banks give loans at high interest rate that rate is higher than they pay to us for our deposit money.

2) Does bank lend our whole money?

No, banks can not lend our whole money and the reason behind it is security of our money. Suppose if banks give loan to creditors and the creditors would unable to pay the money then in this case the bank will go in loss and you will lose your money. To secure your money Central Bank of the Country, in India, Reserve Bank of India (RBI) made some norms i.e. Monetary Policy Rates which are mandatory to follow by all banks.

3) What are these Monetary Policy Rates and how do they help to secure our money?

Recently government formed Monitory Policy Committee with six members group. In this 3 members are from RBI (i.e Governor Urjit Patel, Deputy Governor in charge of Monetary Policy, R. Gandhi and Executive Director Michael Patra) and other 3 members are academics (i.e. Chetan Ghate, associate professor at Indian Statical Institute; Ravindra H Dholakia, professor of economics at Indian Institue

Of Management and Pami Dua, director, Delhi School Of Economics)

Monetary Policy Rates:

a) Bank Rate: It is the rate, which is charged by RBI for providing funds or loans to the banking system (i.e. Commercial Banks, Cooperative Banks, Development Banks, EXIM Banks etc). When RBI wants to control inflation it increases the bank rate. Bank rate is used to lend money for long term upto 1 year.Current Bank Rate: 6.75%

b) Repo Rate: It is the rate at which RBI lends money to banks against government securities with an agreement that banks will repurchase it at predetermined date. Reduction in the Repo Rate helps banks to borrow more money at a cheaper rate while increase in the Repo Rate. Repo rate is used to lend money for short term upto 90 days.Current Repo Rate: 6.25%

Difference between Bank rate and Repo rate

In Bank rate RBI lends money to banks without and government security but on the other hand in Repo rate RBI lends money against government securities.

c) Reserve Repo Rate (RRR): When RBI feels that the liquidity of money is increased in market then to maintain it, RBI offers to Banks to lend their money to RBI at higher interest rates. So RRR is the rate at which RBI borrow money from banks. Current RRR: 5.75%

d) Cash Reserve Ratio: CRR is a certain percentage of deposit money which is maintain by the banks to keep with RBI and on this money RBI never give any interest rate to banks. Current CRR: 4%

e) Statutory Liquidity Ratio:  All commercials banks have to maintain SLR in form of Govt. securities or gold (non-cash). It’s kept as a percentage of Net Demand and Time Liability (NDTL). Current SLR: 20.50%

f) Net Demand & Time Liability (NDTL): When you withdraw money from your account at any time it is called Demand Liability (i.e. Saving accounts and Current accounts). On the other when you can’t withdraw money from your account at any time but you’ll have to wait for a certain time then it’s called Time Liability.

Let’s start to know it with an example.

Suppose you deposit 1 lakh in your bank account.

Bank can’t lend out your whole money. It can lend the part of your money which remains after deducting CRR and SLR from NDTL.

Total NDTL = 1 Lakh Rs

CRR (4%) = 4% of 1 lakh = 1,000 Rs

SLR (20.50%) = 20.50% of 1 Lakh = 20,500 Rs.

Money which can lend by Banks after maintaining CRR & SLR:

1,00,000- (4,000 – 20,500) = 75,500 Rs.

The most important question is why banks maintain SLR and CRR?

Suppose a large number of depositors come to bank to withdraw money at the same time and the cash is not enough to fulfill the demands of its customer then what will bank do? Will bank say to customer that there is no enough cash to fulfill your demands please come tomorrow? No, bank can’t say this because bank is a service provider company and when customers deposit their money in banks they expect that when they need their money, bank will provide it on time. If banks do this, they will loss the trust of its customer. So what banks do in this situation? In this situation, banks will use SLR (non-cash assets). Banks will request to their customers to wait for a while and banks borrow money on SLR form its nearest bank and fulfill their customers demand and will get SLR back soon after paying debts.

CRR is mandatory to maintain by banks and it keeps under RBI. IF, unfortunately, bank faces loss then this amount of customers deposit would be safe under RBI.