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Extra cash in banks' pool

A week ahead of the mid-quarter monetary policy review on Thursday, RBI announced a step that will give banks more money to lend. HT explains the policy instruments that central bank uses to achieve a host of objectives.

india Updated: Mar 13, 2012 21:44 IST
Gaurav Choudhury

What has the RBI done?
In a surprise move, the Reserve Bank of India (RBI) slashed the cash reserve ratio (CRR) by 0.75 percentage points to 4.75%.

What is CRR?
CRR is the proportion of deposits banks have to park with the RBI.

Why has the RBI slashed the CRR?
The CRR cut will inject an estimated Rs 48,000 crore in the pool of banks' lendable resources. It is aimed at making more funds available with banks to match the rising demand from corporations to pay their advance taxes by March 15.

Will the reduction in CRR reduce borrowing rates for customers?
Maybe in a very indirect way. With more cash in hand following the cut in CRR, banks may not need to woo customers by offering higher interest rates to shore up their deposit base. Some banks may even consider lowering the interest they pay to customers on their fixed and savings deposits to cut costs. Lower costs, in turn, could prompt them to reduce their final lending rates.

What is the RBI expected to announce in its mid-quarter review on Thursday?
Analysts do not expect the RBI to reduce the repo rate on Thursday.

What is repo rate?
It is the rate at which the RBI lends to banks. A higher repo pushes up banks' borrowing costs prompting them to increase interest rates for final home, auto and corporate borrowers. It currently stands at 8.5%.

What is reverse repo rate?
It is the rate at which RBI absorbs cash from the system. At higher reverse repo, the central bank would suck cash from the system to stymie demand and cool prices. It currently stands at7.5%.

What is liquidity corridor?
The difference between the repo and reverse repo rates is the liquidity corridor or the liquidity adjustment facility (LAF).

What are policy rates?
The policy rate acts the guide for final lending rates that banks charge from borrowers.

In tight liquidity situations the repo rate acts as the policy rate. In situations of excess liquidity, when banks park money with the RBI from their pool of lendable resources, the reverse repo rate acts the policy rate.

What role do policy rates play in price control?
Till October, the RBI had raised the repo rate 13 times in 19 months to tame prices.

A higher repo would raise banks' borrowing costs, which in turn would raise interest rate on final home, auto and corporate loans.

How does a higher reverse repo rate help in reducing prices?
A higher reverse repo would give banks incentive to park money with RBI, reducing liquidity and demand. A higher reverse repo means it would suck cash from the system to stymie demand and cool prices.

When will the RBI start slashing interest rates?
With inflation showing signs of moderating analysts expect the RBI to start reducing interest rates in annual monetary policy in April.

So, can consumers expect their EMIs to come down?
Not immediately. A lower repo will bring down costs for banks, but banks usually offer lower interest rates only for new customers. Existing home loan borrowers who have borrowed money on floating rates will have to wait longer before banks actually bring down their EMIs.

What about loans on automobiles and consumer goods?
Automobile and consumer goods loans are all on fixed interest rates and, therefore, existing customers are not affected by changes in RBI's policy rates.