Key monetary tools - Banking Sector

Why in news ?
The central bank (RBI) has recently increased its policy repo rate by 25 basis points to 6.25%, for the first time in last four years.


Repo rate

Repo rate or benchmark rate or policy rate is the rate at which the central bank lends short term loans to banks. This rate is increased by RBI to curb liquidity in the market and decreased by RBI to increase the liquidity in market. In this process banks sells government securities to RBI in order to raise money with an agreement to buy them bank on a fixed rate(Repo rate).

Reserve repo rate

Reserve repo rate is the rate at which the central bank (RBI) borrows money from banks for short term, RBI's borrowing from the bank is a policy action that is used to suck money from the market in order to curb liquidity. An increase in Reserve repo rate means that the banks will lend more money to RBI hence less money to be lend to people and this will curbs liquidity in market.

MSF - Marginal Standing facility

MSF - Marginal Standing facility is an emergency tool for banks which is used to get short term loans from the central bank in order to tackle cash shortage like emergency situations against approved government securities. Marginal Standing facility (MSF) is always higher than the repo rate.

Bank Rate

Bank Rate is the rate at which banks borrows money from the central bank for long term loans, without selling or buying any securities. Bank Rate is not used by the central bank for policy formulation. The bank rate is 100 basis points above the repo rate, similarly the repo rate is 100 basis points above the reverse repo rate. This isn?t a rule, but is generally the case.

Cash Reserve Ratio (CRR)

As per RBI guidelines, all banks have to hold some portion of deposits with them in cash, this is called CRR. This deposit can not be used by banks for lending or any other purpose. RBI uses this tool to regulate liquidity in market, with a higher CRR banks will have less money to lend that will curb liquidity, on the other hand when RBI feels to release more money in market to boost economic activities it decreases CRR so that banks will have more money to lend in market.

Statutory Liquidity Ratio (SLR)

As per RBI guidelines, all banks are also required to hold a fixed amount of their deposits in government securities with the RBI, this is called Statutory Liquidity Ratio(SLR). Unlike CRR, banks can earn return on these investments.


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