Key Indicators defining the monetary policy

Today I was watching a news channel and heard that Repo Rate has been reduced by the Reserve bank of India Governor. So I thought of investing some time on the concept of Repo rate, Reverse Repo Rate and CRR and what they mean to a layman like me.

So when I start reading, I get to know including these, there are some more key indicators defined in the monetary policy for the country defined by the central bank of country. In India monetary policies are defined by the Reserve bank of India and are presented from time to time by the RBI governor.

Below are the key indicators defined by the RBI.

Repo Rate is defined as the rate at which the Reserve bank lends money to commercial banks. Repo means Repurchase Obligation agreement. In a repo transaction, a holder of securities (e.g.: the commercial bank) sells the securities to an investor (e.g.: the reserve bank of India), with an agreement to repurchase at a predetermined date and rate. So Repo Rate is the rate at which RBI purchases the securities from the commercial bank with obligation on commercial bank to repurchase the securities at the prevailing repo rate at the agreed rate. This is an interesting topic and deserves a separate article for detailed discussion. Lowering of Repo rate implies banks can now borrow money from the reserve bank at a lower rate. Reverse Repo Rate is the rate at which RBI borrows money from commercial bank. 

Another term we hear regularly during policy commentary is CRR (cash reserve ratio). Cash reserve ratio is the minimum amount of funds that the banks have to keep with the Reserve bank. 

Reverse repo rate and repo rate are used as instrument to keep a check on inflation. The flow of supply from central bank to commercial banks will reduce in case if the repo rate is increased or reverse repo rate is decreased. 

Statutory liquidity ratio (SLR)  is the percentage of money that commercial banks needs to maintain as reserve in the form of gold, cash or government securities before providing any credit to loans. This again is determined and maintained by Reserve bank or central bank

SLR restricts the bank’s leverage in pumping more money into the economy and keeps a check on minimum amount maintained to pay the liabilities that are deposits maintained with the bank. CRR is maintained in cash form with central bank and is used to manage inflation

Bank Rate is the rate at which RBI in India or Central bank of a country allows finance to commercial banks. In case the reserve bank increases/decreases the bank rate, it is an indication of the banks to make changes to interest rates and lending rates.

 In case reserve bank wants more money to flow in the system, it reduces the repo rate. This reverse repo rate is always lower than the repo rate. Reverse repo rate can be increased to reduce flow of money in the system.