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Understanding the repo rate, cash reserve ratio and the Reserve Bank of India

The Reserve Bank of India (RBI) on Tuesday cut the repo rate as well as the cash reserve ratio (CRR) by 25 basis points, or 0.25 percent. Here's a quick explanation of what that means. It will be obvious to some readers, but many people haven't studied economics and are unfamiliar with the terms.

The repo rate, which now stands at 7.75 percent, is the rate at which the central bank lends money to Indian banks. As the repo rate goes down, it gets cheaper for banks to borrow money. That makes it easier for people to borrow money at cheaper rates too. As more people borrow money, which ought to be the result of action like this, they'll spend more money. That's good for the Indian economy.

The CRR, meanwhile, is the amount of funds banks must keep with the RBI. The CRR is at 4 percent, which means for every 100 rupees, the bank keeps 4 rupees with the RBI in cash. The ratio indicates the policy stance of the bank and is used as a tool to manage liquidity, or the amount of money in the system. By changing this ratio, the central bank can control the amount of liquidity. Tuesday's cut would release 180 billion rupees (or about $3.35 billion) into the system, meaning banks would have more money to lend to borrowers.

Cutting the repo rate doesn't always cut lending rates, of course. Banks might worry that lower lending rates could hurt their profits. However, IDBI Bank cut its base rate after the RBI announcement, and the head of India’s top lender, State Bank of India, said banks likely will cut lending rates.

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