Source: The economic times.
The credit policy uses various esoteric terms such as the cash reserve ratio (CRR), reverse repo rates and increased provisioning. While the broad impact of such policy measures is communicated, many loan takers are at a loss to understand how these impact the rate at which they get their housing or auto loan. This story explains the mechanism by which broad monetary measures initiated by the central bank impact you.
After the recent credit policy, where RBI hiked the CRR, most banks have kick started another round of hikes in the prime lending rate (PLR). A hike in this prime lending rate directly impacts rates on loans. Here is what the measures mean for you.
Hike in CRR and its impact
Cash reserve ratio is a portion of deposits every bank has to keep with the RBI as stipulated by the section 42 (1) of the RBI Act 1934. A hike in CRR curbs liquidity by leaving fewer resources for banks to lend out of every rupee deposit they accept. The objective of a hike in CRR is to mop up the excess liquidity in the banking system. But does a hike in CRR have to translate into a rate hike? The broad rationale is that after such a hike, a smaller pool of money is chased by the same number of borrowers. This increases interest rates. But, banking analysts say a hike in CRR may not necessarily push up interest rates immediately. Even as banks park more cash with the RBI as reserves, the banking system may witness surplus liquidity for a temporary period. Hence, unless the demand for credit picks up to the extent that all the money is lent out, banks will not have an incentive to raise interest rates.
Repo & Reverse Repo Rates
The repo and reverse repo rates are the overnight rates of interest that a bank pays or earns for borrowing and lending money, respectively, to the Reserve Bank of India against/for government securities. These rates set the floor and ceiling for risk-free overnight borrowing and lending. Any loans to corporates/individual will have to be done by adding the risk premium depending on the credit rating of the borrower. The repo and reverse repo rates set the direction for other lending rates. A rise in the reverse repo rate translates into a higher cost of borrowing for ordinary customers because if banks have the option to earn say x% by lending risk-free to RBI, they will want to earn more when they lend to others. Also, when RBI raises the reverse repo rate, it may reduce the overall liquidity available for lending to borrowers as some banks may find it attractive to lend to RBI. Sometimes, RBI may not tinker with the key rates in the monetary policy, but it may drop a hint on the future direction of interest rates. Always read between the lines of the policy to see if the central bank governor says interest rates are likely to be neutral but may harden in the short to medium term. Then you could be more proactive to structure your borrowings and investments accordingly.
Hike in Reverse Repo
Banking experts say, the interest rate on fixed deposits are often triggered by at least a 0.5% hike in the reverse repo rate. But a 0.25% hike in the reverse repo rate is enough to push up the lending rates. This is because of the fine pricing of loans products in the market because of cutthroat competition.
Hike in Provisioning Requirement
This simply means that banks will now need to provide more capital while disbursing loans or on the borrowers’ credit card outstanding. Higher provisioning curtails overall lending to some extent as more money has to be set aside for every rupee lent. These measures result in lending to these sectors becoming more costly, thereby pushing up rates. A higher provisioning, apart from setting aside more capital, also impacts the bank’s bottomline.
After the recent credit policy, where RBI hiked the CRR, most banks have kick started another round of hikes in the prime lending rate (PLR). A hike in this prime lending rate directly impacts rates on loans. Here is what the measures mean for you.
Hike in CRR and its impact
Cash reserve ratio is a portion of deposits every bank has to keep with the RBI as stipulated by the section 42 (1) of the RBI Act 1934. A hike in CRR curbs liquidity by leaving fewer resources for banks to lend out of every rupee deposit they accept. The objective of a hike in CRR is to mop up the excess liquidity in the banking system. But does a hike in CRR have to translate into a rate hike? The broad rationale is that after such a hike, a smaller pool of money is chased by the same number of borrowers. This increases interest rates. But, banking analysts say a hike in CRR may not necessarily push up interest rates immediately. Even as banks park more cash with the RBI as reserves, the banking system may witness surplus liquidity for a temporary period. Hence, unless the demand for credit picks up to the extent that all the money is lent out, banks will not have an incentive to raise interest rates.
Repo & Reverse Repo Rates
The repo and reverse repo rates are the overnight rates of interest that a bank pays or earns for borrowing and lending money, respectively, to the Reserve Bank of India against/for government securities. These rates set the floor and ceiling for risk-free overnight borrowing and lending. Any loans to corporates/individual will have to be done by adding the risk premium depending on the credit rating of the borrower. The repo and reverse repo rates set the direction for other lending rates. A rise in the reverse repo rate translates into a higher cost of borrowing for ordinary customers because if banks have the option to earn say x% by lending risk-free to RBI, they will want to earn more when they lend to others. Also, when RBI raises the reverse repo rate, it may reduce the overall liquidity available for lending to borrowers as some banks may find it attractive to lend to RBI. Sometimes, RBI may not tinker with the key rates in the monetary policy, but it may drop a hint on the future direction of interest rates. Always read between the lines of the policy to see if the central bank governor says interest rates are likely to be neutral but may harden in the short to medium term. Then you could be more proactive to structure your borrowings and investments accordingly.
Hike in Reverse Repo
Banking experts say, the interest rate on fixed deposits are often triggered by at least a 0.5% hike in the reverse repo rate. But a 0.25% hike in the reverse repo rate is enough to push up the lending rates. This is because of the fine pricing of loans products in the market because of cutthroat competition.
Hike in Provisioning Requirement
This simply means that banks will now need to provide more capital while disbursing loans or on the borrowers’ credit card outstanding. Higher provisioning curtails overall lending to some extent as more money has to be set aside for every rupee lent. These measures result in lending to these sectors becoming more costly, thereby pushing up rates. A higher provisioning, apart from setting aside more capital, also impacts the bank’s bottomline.
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