Engineer's Finance

As a statutory obligation under Section 24 (b) of the Banking Regulation Act, 1949, every bank has to keep a fixed minimum portion of their Net Demand (savings account) and Time (fixed deposits) Liabilities (NDTLs) aside at the end of every day.

The SLR can be in the form of cash, gold or bonds issued by the government (a financial instrument for which the government pays a fixed rate of interest to the buyer).

While demand deposits can be withdrawn any time without giving any prior notice, time deposits need a notice period for their withdrawal.

The SLR is always expressed as a percentage of the NDTL. If a bank’s NDTL is Rs 100 on January 31 and the SLR fixed by the RBI is at 20%, then that bank has to either keep Rs 20 aside or invest it in gold, bonds or both. This means that only Rs 80 will be available to the bank for its lending operations.

The savings account deposits as well as fixed deposit amount that we deposit in a bank are the bank’s liabilities. The SLR as of today stands at 25% and the RBI has the authority to increase it to a maximum of 40%.

Any reduction in the SLR level increases the amount of money available with banks for lending to individuals, companies or other banks. Any hike in the SLR has the opposite effect.

How this affects us: A reduction in SLR, ideally, means you should have to pay a cheaper rate of interest on your loans and vice versa.

This is the rate at which banks lend money to their prime customers. This rate is often lower than the rate at which banks lend money to their other customers.

Most PLR customers are top blue-chip companies that have excellent credit records (have never defaulted on their interest payments to the banks from which they borrowed money).

If the RBI increases the bank rate, banks will go ahead and increase their PLRs.

How this affects us: This, in turn, will increase your home loan rates as they are linked to (benchmarked to) PLRs. Home loan rates are always priced below a bank’s PLR as they fall under the priority sector category.

Personal loans and vehicle loans, on the other hand, are always priced above a bank’s PLR.

This is the mechanism through which the RBI drains out funds (reverse repo) or injects money (repo rate) into the banking system.

Actually this is the window through which the RBI conducts its repos and reverse repos.

RBI conducts both these operations depending on the demand and supply of funds in the banking system. If RBI thinks that there is more money chasing few goods it drains out the excess by opening the reverse repo window. If the money supply is tight, RBI opens the repo window.

This is the exact opposite of repo rate.

The rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed the reverse repo rate. The RBI uses this tool when it feels there is too much money floating in the banking system; this too leads to inflation.

For example, take a look at the housing industry today — there is so much of money available in terms of bank loans and increased salaries that the prices for homes, and for land, has sky-rocketed.

If the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer them a lucrative rate of interest. As a result, banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain amount of risk)

Consequently, banks would have lesser funds to lend to their customers. This helps stem the flow of excess money into the economy.

Though RBI can use both repo and reverse repo to control the amount of money in the system, it is the reverse repo that the RBI prefers as a credit management tool. It was only during the October 2006 credit policy that the RBI, after a long gap, increased repo rate to control inflation.

As of today, the reverse repo rate stands at 6% and the repo rate is 8.5% . Any monetary authority lends money at a higher rate and borrows at a lower rate. RBI, too, is a clever money manager. It lends money to banks at 8.5% per cent (repo rate) and borrows money from banks (reverse repo rate) at only 6 per cent, maintaining a neat difference/ profit of 2.5 per cent.

How this affects us: Again, if the RBI increases the reverse repo rate, consider it bad news. It means the banks have less money to lend — since they will keep quite a bit of it with the RBI. As a result, we will have to pay a higher rate of interest if we are planning to apply for a loan.

If we are lucky, though, and the bank does not want to lose us as a clients, it may absorb the increased interest and not pass the cost to us. But that generally does not happen and we all know that. Everyone wishes to wash their hands off when the times are difficult.

Repo rate is the rate at which banks borrow funds from the RBI to meet the gap between the demand they are facing for money (loans) and how much they have on hand to lend.

If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

How this affects us: If the bank is paying a higher rate of interest to borrow money, we are the one who will bear the cost — we will pay a higher rate of interest when we borrow money from them. This is how banks ensure that they continue to make a profit.

For example, let’s say you need money for some reason and you apply for a loan. The bank may have already exhausted all its available money by lending to other borrowers and does not have enough money to lend to you. This does not mean it will refuse your loan request.

The bank will go to the RBI and ask for money. The RBI lends this money to the bank at a fixed rate of interest (the repo rate fixed during the credit policy; the credit policy is announced every quarter). This tool helps the RBI increase the amount of money flowing into an economy (that is, it brings more money, as and when needed, into the banking system).

As of now, the Repo Rate is 8.5%.