Banking terminologies are useful to understand the changes in the monetary policy made by the RBI and the steps taken by the government for the economy. It is essential to know these terminologies for the bank exam preparation. It also helps in comprehending the current affair news related to it. The most used and heard banking terminology is Repo Rate.
Let us understand the meaning of repo rate, reverse repo rate, other banking terminologies related to it, and how does it help the economy. Let's dig deep inside:
Important Indian Banking Terminologies
- Bank rate is the rate of interest that a Central bank (RBI in India) charges on the loans and advances to a commercial bank.
- This means, it is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers for the long term.
- Managing the bank rate is a method by which central banks (RBI) affect economic activity.
- Lowering the bank rates can help to expand the economy by lowering the cost of funds for borrowers, and higher bank rates can help to reign in the economy when inflation is higher than desired.
- It is also called as the discount rate.
Liquidity Adjustment Facility (LAF)
LAF is a tool used by RBI to control short-term money supply. It has two instruments: Repo Rate and Reverse Repo Rate.
1. Repo Rate
- Repo rate, also known as Repurchase Rate is the rate at which the Central bank (RBI in India) lends money to commercial banks.
- It is the rate at which RBI lends money to commercial banks.
- Repo rate is usually a short term loan for up to 2 weeks.
- Repo rate is used by monetary authorities to control inflation, control credit availability and maintain economic growth.
- Repo rate determines the interest rates on loans and the interest earned from the bank.
- It refers to the rate at which commercial banks borrow money by selling their securities to the Central bank of our country i.e Reserve Bank of India (RBI) to maintain liquidity, in case of shortage of funds or due to some statutory measures.
- It is one of the main tools of RBI to keep inflation under control.
Let us have a quick glance at the difference between Bank Rate and Repo Rate-
- Bank rate is offered against the loans provided by the Central bank to commercial banks. Repo rate is usually offered for repurchasing securities, that are sold by commercial banks to the central bank.
- Repo rate is usually for short term financial requirements while bank rate serves the long term financial needs of the banks.
- The Repo rate is always lower than the Bank rate.
- Securities, bonds, agreements, and collaterals are involved in the case of the Repo rate. In the case of a bank rate, no collateral is involved.
2. Reverse Repo Rate
- Reverse Repo Rate is defined as the interest rate, offered by RBI to the commercial banks within the country, to deposit their surplus funds with RBI for a short period of time.
- Reverse Repo Rate is just the opposite of Repo Rate.
- The banks gain an interest rate on government securities bought from the RBI for the given period in Reverse Repo Rate
- It is always lower than the Repo Rate.
- An increase in reverse repo rate can prompt banks to park more funds with the RBI to earn higher returns on idle cash.
- It is also a tool which can be used by the RBI to drain excess money out of the banking system.
Marginal Cost of Funds based Lending Rate (MCLR)
MCLR is an acronym for the Marginal Cost of Funds based Lending Rate. It replaced the Base Rate system from April 2016. (Base Rate is the minimum rate, as set by the RBI, below which banks are not allowed to lend to its customers). MCLR is a tenor- based internal benchmark lending rate, instead of a single rate. The banks can now price their loans, as per their funding composition and strategies on different MCLRs. Banks need to review and publish their MCLR monthly.
Cash Reserve Ratio (CRR)
- Cash Reserve Ratio (CRR) is the amount of funds that the banks are bound to keep with Reserve bank of India as a certain percentage of their Net Demand and Time Liabilities (NDTL).
- Bank cannot lend this amount.
- Bank earns no interest rate or profit on this CRR
- All Scheduled Commercial Bank must keep CRR as per set by Monetary Policy Committee (MPC) but RBI may prescribe separate norms/ slabs for RRBs and Cooperative Banks.
- When CRR is reduced, banks are required to keep fewer funds with RBI and resource available to banks for lending will go up, which can in turn result in enhanced liquidity in the market.
Statutory Liquidity Ratio (SLR)
- All commercial banks in India are required to keep a given percentage of their demand and time deposits (Net demand and time liabilities or NDTL) as liquid assets in their vault itself.
- It prevents the bank from lending all its deposits which is too risky.
- If SLR increases, banks need to keep more liabilities (deposits) with them and provides less loans to people and vice versa.
Marginal Standing Facility (MSF)
- In MSS, RBI sells Govt securities, Treasury bills and Cash Management Bills to absorb excess liquidity in the market.
- The money obtained after selling these securities does not become part of Govt’s borrowing but Govt has to pay interest on it.
We already explained the difference between Bank Rate and the Repo rate. Now, have a look at the table below:
Duration for which it is offered
Collateral/ Securities involved
For Long Term Loans
For Short Term Loans
Marginal Standing Facility
For Overnight Loans
RBI Monetary Policy Rates
Here are the present rates as per the monetary policy report published in June:
|Reverse Repo Rate||3.35%|
|Marginal Standing Facility (MSF) Rate||4.25%|