RBI hikes Repo Rate and CRR

• 06 May 2022

For Prelims: RBI, Repo Rate, Reverse Repo Rate, Monetary Policy, Monetary Policy Committee (MPC).

For Mains: Monetary Policy, Growth & Development, RBI and its Monetary Policy Tools.

Why in News?

The Reserve Bank of India’s Monetary Policy Committee (MPC) has increased the policy Repo Rate by 40 basis points to 4.40%, with immediate effect and Cash Reserve Ratio (CRR) of banks by 50 basis points to 4.5% of Net Demand and Time Liabilities (NDTL).

This is the first increase in the policy repo rate by RBI since May 2020.

What is the Monetary Policy Committee?

• It is a statutory and institutionalized framework under the Reserve Bank of India Act, 1934, for maintaining price stability, while keeping in mind the objective of growth.
• The Governor of RBI is ex-officio Chairman of the committee.
• The MPC determines the policy interest rate (repo rate) required to achieve the inflation target (4%).
• An RBI-appointed committee led by the then deputy governor Urjit Patel in 2014 recommended the establishment of the Monetary Policy Committee.

What are the Rates Now?

• Policy Repo Rate: 4.40%
  • Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds. Here, the central bank purchases the security.
• Standing Deposit Facility (SDF): 4.15%
  • The SDF is a liquidity window through which the RBI will give banks an option to park excess liquidity with it.
  • It is different from the reverse repo facility in that it does not require banks to provide collateral while parking funds.
• Marginal Standing Facility Rate: 4.65%
  • MSF is a window for scheduled banks to borrow overnight from the RBI in an emergency situation when interbank liquidity dries up completely.
    • Under interbank lending, banks lend funds to one another for a specified term.
• Bank Rate: 4.65%
  • It is the rate charged by the RBI for lending funds to commercial banks.
• CRR: 4.50% (Effective from 21st May, 2022)
  • Under CRR, the commercial banks have to hold a certain minimum amount of deposit (NDTL) as reserves with the central bank.
• SLR: 18.00%
  • Statutory Liquidity Ratio or SLR is the minimum percentage of deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities.

Why has RBI hiked Repo Rate and CRR?

• The decision has been taken in view of the global scenario, wherein there has been a sharp rise in inflation due to current geopolitical tensions.
  • Inflation has risen to its highest level in the last 3-4 decades in major economies with global crude oil prices remaining volatile and above USD 100 per barrel.
• The hike in Repo rate and CRR is aimed at reining in elevated inflation amid the global turbulence in the wake of the Ukraine war.
• The RBI aimed to keep inflation – which is already close to 7% — at its desired level and control and monitor money flow into the banking system.
  • There has also been a spike in fertiliser prices and other input costs, which has a direct impact on food prices in India.
  • There was a spike in the headline CPI (Consumer Price Inflation) inflation to 6.95% in March 2022.
• There is the collateral risk if inflation remains elevated at these levels for too long.
  • Collateral Risk: The risk of loss arising from errors in the nature, quantity, pricing, or characteristics of collateral securing a transaction with credit risk.
  • Collateral is an item of value used to secure a loan (credit).

What would be the Impact of Repo Rate and CRR Hike?

• Repo Rate:
  • It is expected to push up interest rates in the banking system. Equated Monthly Installments (EMIs) on home, vehicle and other personal and corporate loans are likely to go up.
  • Deposit rates, mainly fixed term rates, are also set to rise.
  • Consumption and demand can be impacted by the Repo rate hike.
• CRR:
  • The hike in CRR will suck out Rs 87,000 crore from the banking system. The lendable resources of banks will come down accordingly.
  • It also means the cost of funds will go up and banks’ net interest margins could get adversely impacted.
    • Net interest margin (NIM) is a measure of the difference between the interest income earned by a bank or other financial institution and the interest it pays out to its lenders (for example, depositors), relative to the amount of their assets that earn interest.

UPSC Civil Services Examination, Previous Year Questions

Q. If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do? (2020)

1. Cut and optimize the Statutory Liquidity Ratio

2. Increase the Marginal Standing Facility Rate

3. Cut the Bank Rate and Repo Rate

Select the correct answer using the code given below:

(a) 1 and 2 only

(b) 2 only

(c) 1 and 3 only

(d) 1, 2 and 3

Ans: (b)

• Expansionary monetary policy, or easy monetary policy, is when a central bank uses its tools to stimulate the economy. It increases the money supply, lowers interest rates and increases demand. It boosts economic growth.
• Raising SLR makes banks park more money in government securities and reduce the level of cash in the economy. Doing the opposite helps maintain cash flow in the economy. Hence, statement 1 is not correct.
• With the increase of MSF Rate, cost of borrowing increases for banks resulting in reduced available resources to lend. Hence, statement 2 is correct.
  • Under expansionary monetary policy, RBI reduces repo rate and bank rate to increase liquidity in the banking sector. Hence, statement 3 is not correct.
  • Therefore, option (b) is the correct answer.

Source: TH