Investing 101

What does the RBI do? What is Repo , Reverse Repo , CRR & SLR? What is the effect of such rates on the Stock Market?

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Repo rate , CRR , SLR , Bank Rate – All these are complex sounding RBI Policy Jargons but I assure you this article will tell you what it means in a very simple manner.

What is RBI?

The Reserve Bank of India (RBI) is the central bank of India, which was established on April 1, 1935, under the Reserve Bank of India Act. The Reserve Bank of India uses monetary policy to create financial stability in India, and it is charged with regulating the country’s currency and credit systems. In the same way our Mother manages the finances in their household through expenditure and savings , the same way RBI manages our country’s finances through a variety of tools.

What does the RBI do?

The main purpose of the RBI is to conduct consolidated supervision of the financial sector in India, which is made up of commercial banks, financial institutions and nonbanking finance firms. Initiatives taken on by the RBI include restructuring bank inspections, introducing off-site surveillance of banks and financial institutions and strengthening the role of auditors.

First and foremost, the RBI formulates, implements and monitors India’s monetary policy. Its management objective is to maintain price stability and ensure that credit is flowing to productive economic sectors. It also manages all foreign exchange under the Foreign Exchange Management Act of 1999. This act allows the RBI to facilitate external trade and payment in order to promote the development and health of the foreign exchange market in India.

It acts as a regulator and supervisor of the overall financial system. This injects public confidence into the national financial system, protects interest rates and provides positive banking alternatives to the public. Finally, the RBI acts as the issuer of national currency. For India, this means that currency is either issued or destroyed, depending on its fit for current circulation. This provides the Indian public with monetary supplies of currency in the form of dependable notes and coins, a lingering issue in India.

1. Issue of Bank Notes:

The Reserve Bank of India has the sole right to issue currency notes except one rupee notes which are issued by the Ministry of Finance. Currency notes issued by the Reserve Bank are declared unlimited legal tender throughout the country.

This concentration of notes issue function with the Reserve Bank has a number of advantages: (i) it brings uniformity in notes issue; (ii) it makes possible effective state supervision; (iii) it is easier to control and regulate credit in accordance with the requirements in the economy; and (iv) it keeps faith of the public in the paper currency.

2. Banker to Government:

As banker to the government the Reserve Bank manages the banking needs of the government. It has to-maintain and operate the government’s deposit accounts and collect receipts of funds and makes payments on behalf of the government. At the same time it also represents the Government of India as the member of the IMF and the World Bank.


3. Custodian of Cash Reserves of Commercial Banks:

The commercial banks hold deposits in the Reserve Bank and the latter has the custody of the cash reserves of the commercial banks.

4. Custodian of Country’s Foreign Currency Reserves:

The Reserve Bank has the custody of the country’s reserves of international currency, and this enables the Reserve Bank to deal with crisis connected with adverse balance of payments position.

5. Lender of Last Resort:

The commercial banks approach the Reserve Bank in times of emergency to tide over financial difficulties, and the Reserve bank comes to their rescue though it might charge a higher rate of interest.

6. Central Clearance and Accounts Settlement:

Since commercial banks have their surplus cash reserves deposited in the Reserve Bank, it is easier to deal with each other and settle the claim of each on the other through book keeping entries in the books of the Reserve Bank. The clearing of accounts has now become an essential function of the Reserve Bank.

7. Controller of Credit:

Since credit money forms the most important part of supply of money, and since the supply of money has important implications for economic stability, the importance of control of credit becomes obvious. Credit is controlled by the Reserve Bank in accordance with the economic priorities of the government.

Meanings of Various RBI Policy Jargons:

Repo (Repurchase) Rate

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.

Reverse Repo Rate

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 systemIf 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

Reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks, while repo signifies the rate at which liquidity is injected.

Bank Rate

This is the rate at which RBI lends money to other banks (or financial institutions . The bank rate signals the central bank’s long-term outlook on interest rates. If the bank rate moves up, long-term interest rates also tend to move up, and vice-versa.Banks make a profit by borrowing at a lower rate and lending the same funds at a higher rate of interest. If the RBI hikes the bank rate (this is currently 6 per cent), the interest that a bank pays for borrowing money (banks borrow money either from each other or from the RBI) increases. It, in turn, hikes its own lending rates to ensure it continues to make a profit.

Call Rate

Call rate is the interest rate paid by the banks for lending and borrowing for daily fund requirement. Si nce banks need funds on a daily basis, they lend to and borrow from other banks according to their daily or short-term requirements on a regular basis.

CRR

Also called the cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation by tying their hands in lending money

SLR

Besides the CRR, banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements. What SLR does is again restrict the bank’s leverage in pumping more money into the economy.

Rate Percentages as of July 2017. (Source Link)

CRR and SLR : If RBI decides to increase the percentages of CRR & SLR the available credit at the disposal of the banks goes down. This in turn has an effect on the credit available to the public because they can borrow less. The increased cost of borrowing also hits the borrower. Due to lack of available credit, there is less demand of goods & services, which ultimately has an impact on the profit of companies. This has a negative impact on the prices of the stocks in the nse market. It is difficult to predict to what extent or how the stock market will react to the RBI policy on intraday basis or long term basis, but it does bring about a negative/positive buzz in the financial community.

 Repo & Reverse Repo rate : If the repo rate or the bank rate is increased, bank has to pay more interest to the central bank. So in order to make a profit, banks in turn increase the interest rate at which they lend money to the customer. This dissuades the customers in taking credit from banks, leading to a shortage of money in the economy and less liquidity. An increase in Reverse repo rate means that the central bank now pays more interest to the banks for depositing their money with it.

How do these RBI Policy rates affect the Stock Market?

High interest rates hurt company profits

In the first half of the financial year 2012-13, companies across sectors paid 3.7% of their sales as interest, according to RBI’s monthly bulletin for January 2013. This was just 1.6% four years ago. This ate into company profits. The net profit as a percentage of sales for companies stood at 6.4% in the first half of 2012-13 against 9.2% four years ago

Small companies hit most

The RBI study of small, medium and large listed companies suggests that small and medium sized companies are hit hardest due to high interest rates. Banks make small companies pay higher interest rate than large companies. The interest paid as a percentage of sales was 9.2% for small companies, 5.8% for medium companies and 3.3% for large companies. RBI defines small companies as those with sales of less than Rs 100 crore. Medium sized companies have sales between Rs 100 crore to Rs 1,000 crore. Large sized companies are those with sales of over Rs 1,000 crore.

High interest rates reduce domestic participation in stock markets

Investors tend to keep their money in fixed deposits or fixed return assets when interest rates are high. Indian investors pulled out money from equity markets in 2012. For January 2013, mutual funds were net sellers to the tune of Rs 2,770 crore, according to Securities and Exchange Board of India.This means investors in India do not feel the need to take any risk and bet on equity markets. In contrast, low interest rates in US and others markets drove foreign institutional investors to risky assets in emerging markets. In January 2013 so far, FIIs have injected $ 3bn in Indian equity markets.

High interest rates slow growth

Growth of companies and expansion will get affected due to persistent high interest rates. Companies struggle to repay existing loans and put on hold expansion plans. This results in fewer jobs than before. Companies also cut spending and consume less. This reduces the demand for goods and services and slows economic growth.

Sectoral Impact

Banking: The banking space will be the first one to reap the benefits of a rate cut. The reason being decrease in their cost of funds. It will be positive for both private as well as public sector banks in general.

Auto: The rate cut will result in lower lending rates. This will boost demand for the auto sector, especially two-wheeler makers ahead of festival season.

Infrastructure & power sectors: The infrastructure and power sectors are the ones that can reap the benefits of a drop in interest rates, because most the companies in this sector are debt laden and require massive fund infusion at regular intervals.

I hope you found this article helpful,

Thanks,

-ASLNK

Meaning of Various Stock Market Jargons.

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