Dear Friends,
In last month or so every body have read the words "CRR" "repo rate" & SLR in News paper and wanted to know about it and interested in its effect on various things like Inflation,bank Interest rate and stock price of Bank and other Interest rate sensitive stocks .so we have divided this story in three parts.
(A) Meaning of terms
(B) Impact on Inflation & interest rates
(C) other measure which can be taken
(A) Meaning of terms
- CRR(Cash Reserve Ratio):Cash reserve Ratio (CRR) is the amount of Cash(liquid cash like gold) that the banks have to keep with RBI. This Ratio is basically to secure solvency of the bank and to drain out the excessive money from the banks. If RBI decides to increase the percent of this, the available amount with the banks comes down and if RBI reduce the CRR then available amount with Banks increased and they are able to lend more.RBI has reduced this ratio three times and reduced it from 9 % to 5.5% in last one month or so.
- Repo Rate:Repo rate is the rate at which our banks borrow rupees from RBI. This facility is for short term measure and to fill gaps between demand and supply of money in a bank .when a bank is short of funds they they borrow from bank at repo rate and if bank has a surplus fund then the deposit the funds with RBI and earn at Reverse repo rate .So reverse Repo rate is the rate which is paid by RBI to banks on Deposit of funds with RBI.A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.To borrow from RBi bank have to submit liquid bonds /Govt Bonds as collateral security ,so this facility is a short term gap filling facility and bank does not use this facility to Lend more to their customers.present rate is 7.5% and reverse repo rate is 6%.
- SLR((Statutory Liquidity Ratio) is the amount a commercial bank needs to maintain in the form of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers. SLR rate is determined and maintained by the RBI (Reserve Bank of India) in order to control the expansion of bank credit.Generally this mandatory ration is complied by investing in Govt bonds.present rate of SLR is 24 %.But Banks average is 27.5 % ,the reason behind it is that in deficit budgeting Govt landing is more so they borrow money from banks by selling their bonds to banks.so banks have invested more than required percentage and use these excess bonds as collateral security ( over and above SLR )to avail short term Funds from the RBI at Repo rate.
Impact on Inflation and Interest rates:
As we all have read the famous line "if all thing remain the same ......".so In all my below paragraphs please note that there are many assumption in fixing the relation between this ratio and interest rates .
SLR and Cash reserve ratio is maintained for bank solvency and Higher ratio of SLR and CRR makes bank relatively safe as higher ratio means they have more of their funds deposited in liquid securities and can fulfill the demand on redemption of deposit from the Bank.lets take an example :suppose a Bank has taken a deposit of 100 from public and CRR is 9 and SLR is 25 then available funds to lend from deposits with the bank will be 100-9-25=66 so their is direct relation between CRR ,SLR and Funds available with bank to lend to public out of deposit received from public .
Now take point what will be the impact on Interest rates of this ratio:Interest rate are fixed on the Demand supply situation of the amount available with person who want to lend and and person who want to borrow and interest rate is fixed on demand supply of the funds if demand is more and supply is less then interest rate rises up and if demand is less and supply is excessive then interest rate comes down .this relation is based on many assumption as said above.
So RBI is controlling the supply side of the Funds and by changes in CRR and SLR they effective control the supply side of the money.so when RBI increase these ratio then available funds with the banks will go down and as demand remain the same then people will have to pay more as interest and interest rate will go up.On the reverse if RBI reduce these rates ,then amount available with bank for lending will be increased and they have to reduce rates to lend more.In these situation bank also reduce the rate of higher short term deposit from public as they have surplus money already to lend.so these rates have double impact the first direct effect is bank reduce rate of lending so more money is available with people and second is interest on Deposit will be reduced so more money will be available with the people.
As from the above para we have understood that how these ratio reduce or increase the money supply in the system and we know if more person is demanding few goods then price of goods tends to increase and its called inflation so when RBI reduce these ratios then money supply in market increases and inflation is rises further but in present case this is not the correct and right relation.This time the reduction of these ratio is to maintain liquidity without disturbing inflation much.while marked is falling and each and every commodity rate going downwards.In these situation after increasing of money supply inflation rate does not goes up as the demand is slow and reduction in commodity prices will nullify the impact of increase in money supply and have less inflationary effects.
Measure which may be taken in this Crise:(this is based on measures taken by other countries )
- Share market:Govt should create a Fund which may be called as Market stablisation fund ,which should me managed by professional agency and should buy good reputed stock from the Market when share are available at throw away prices and sell them when they seems to be overvalued.and the purpose of the fund should be stablisation of the market and welfare of the Investor and not to earn a profit from the market and buying and selling should be on the basis of Long term period.By doing this sentimate will improve ,volitality will be reduced and selling from large FII can be absorbed and in my point of view there is no chance of loss in these venture.To start with 5000-10000 cr fund is enough.russian govt has adopted this system.
- Buying of stocks of private sector Banks:if govt By sybolically purchase shares of some major private banks then it will improve the sentimate and increse the confidense of public in private sector bank .This measures Indicate that banks are sound and govt is also investing in them .More over money received from selling of shares also improve the liquidity position of the banks
by Karan Dhadda
you can add more if you wish to ,in comment section.
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