Repo Rate – Meaning, Reverse Repo

Rate & Current Repo Rate

Reverse Repo Rate is when the RBI borrows money from banks when there is excess
liquidity in the market. ... During high levels of inflation in the economy, the RBI increases
the reverse repo. It encourages the banks to park more funds with the RBI to earn higher
returns on excess funds.

Repo rate refers to the rate at which commercial banks borrow money by selling their
securities to the Central bank of our country i.e Reserve Bank of India (RBI) to maintain
liquidity, in case of shortage of funds or due to some statutory measures. It is one of the main
tools of RBI to keep inflation under control.

1. How Does Repo Rate Work?

When you borrow money from the bank, the transaction attracts interest on the principal
amount. This is referred to as the cost of credit. Similarly, banks also borrow money from
RBI during a cash crunch on which they are required to pay interest to the Central Bank. This
interest rate is called the repo rate.
Technically, repo stands for ‘Repurchasing Option’ or ‘Repurchase Agreement’. It is an
agreement in which banks provide eligible securities such as Treasury Bills to the RBI while
availing overnight loans. An agreement to repurchase them at a predetermined price will also
be in place. Thus, the bank gets the cash and the central bank the security.

2. What are the Components of a Repo

Transaction?
Below are the parameters on the basis of which the RBI agrees to execute the transaction with
the banks:
Preventing Economy “squeezes” – The Central bank increases or decreases the Repo rate
depending on the inflation. Thus, it aims at controlling the economy by keeping inflation in
the limit.
Hedging & Leveraging – RBI aims to hedge and leverage by buying securities and bonds
from the banks and provide cash to them in return for the collateral deposited.
Short-Term Borrowing – RBI lends money for a short period of time, maximum being an
overnight post which the banks buy back their securities deposited at a predetermined price.
Collaterals & Securities – RBI accepts collateral in the form of gold, bonds etc.
Cash Reserve (or) Liquidity – Banks borrow money from RBI to maintain liquidity or cash
reserve as a precautionary measure.
3. How Does Repo Rate Affect the Economy?
Repo rate is a powerful arm of the Indian monetary policy that can regulate the country’s
money supply, inflation levels, and liquidity. Additionally, the levels of repo have a direct
impact on the cost of borrowing for banks. Higher the repo rate, higher will be the cost of
borrowing for banks and vice-versa.

a. Rise in inflation
During high levels of inflation, RBI makes strong attempts to bring down the flow of money
in the economy. One way to do this is by increasing the repo rate. This makes borrowing a
costly affair for businesses and industries, which in turn slows down investment and money
supply in the market. As a result, it negatively impacts the growth of the economy, which
helps in controlling inflation.

b. Increasing Liquidity in the Market

On the other hand, when the RBI needs to pump funds into the system, it lowers the repo rate.
Consequently, businesses and industries find it cheaper to borrow money for different
investment purposes. It also increases the overall supply of money in the economy. This
ultimately boosts the growth rate of the economy.

4. What is Meant by Reverse Repo Rate?

Reverse Repo Rate is a mechanism to absorb the liquidity in the market, thus restricting the
borrowing power of investors.
Reverse Repo Rate is when the RBI borrows money from banks when there is excess
liquidity in the market. The banks benefit out of it by receiving interest for their holdings
with the central bank.
During high levels of inflation in the economy, the RBI increases the reverse repo. It
encourages the banks to park more funds with the RBI to earn higher returns on excess funds.
Banks are left with lesser funds to extend loans and borrowings to consumers.
 

Repo Rate Reverse Repo Rate

It is the rate at which RBI lends money to banks It is the rate at which RBI borrows money
from banks

It is higher than the reverse repo rate It is lower than the repo rate

It is used to control inflation and deficiency of It is used to manage cash-flow

funds

It involves the sale of securities which would be It involves the transfer of money from one
 repurchased in future. account to another.

5. Current Repo Rate and its Impact

RBI keeps changing the repo rate and the reverse repo rate according to changing
macroeconomic factors. Whenever RBI modifies the rates, it impacts all sectors of the
economy; albeit in different ways. Some segments gain as a result of the rate hike while
others may suffer losses. RBI recently cut down the repo rate by 25 basis points to 5.15%
from 5.75%. In the same line, the reverse repo rate was also reduced to 4.9% from 5.5%.
Changes in the repo rates can directly impact big-ticket loans such as home loans. The
decrease in repo rates is to aim at bringing in growth and improving economic development
in the country. Consumers will borrow more from banks thus stabilizing the inflation.
A decline in the repo rate can lead to the banks bringing down their lending rate. This can
prove to be beneficial for retail loan borrowers. However, to bring down the loan EMIs, the
lender has to reduce its base lending rate. As per the RBI guidelines, banks/financial
institutions are required to transfer the benefit of interest rate cuts to consumers as soon as
possible.

CRR and SLR implications

The Central Bank controls the liquidity in the Banking system with CRR. In the case of SLR,
the securities are kept with the banks themselves, which they need to maintain in the form of
liquid assets. In CRR, the cash reserve is maintained by the banks with the Reserve Bank
of India.

Cash Reserve Ratio (CRR) RBI meaning, CRR rate: The Cash Reserve

Ratio in India is decided by RBI’s Monetary Policy Committee in the periodic
Monetary and Credit Policy. The Reserve Bank of India takes stock of the CRR
in every monetary policy review, which, at present, is conducted every six
weeks. CRR is one of the major weapons in the RBI’s arsenal that allows it to
maintain a desired level of inflation, control the money supply, and also
liquidity in the economy. The lower the CRR, the higher liquidity with the
banks, which in turn goes into investment and lending and vice-versa. Higher
CRR can also negatively impact the economy as lesser availability of loanable
funds, in turn, slows down investment. It thereby reduces the supply of money
in the economy.

What is CRR or Cash Reserve Ratio?

The Reserve Bank of India or RBI mandates that banks store a proportion of
their deposits in the form of cash so that the same can be given to the bank’s
customers if the need arises. The percentage of cash required to be kept in
reserves, vis-a-vis a bank’s total deposits, is called the Cash Reserve Ratio. The
 cash reserve is either stored in the bank’s vault or is sent to the RBI. Banks do
not get any interest on the money that is with the RBI under the CRR
requirements.

Functions of IRDA

 To protect the interest of and secure fair treatment to policyholders;

 To bring about speedy and orderly growth of the insurance industry (including
annuity and superannuation payments), for the benefit of the common man, and to
provide long term funds for accelerating growth of the economy;

--IRDA - Insurance Regulatory Development and Authority is the statutory,

independent and apex body that governs and supervise the Insurance
Industry in India.

o It was constituted by Parliament of India Act called Insurance

Regulatory and Development Authority of India (IRDA of
India) after the formal declaration of Insurance Laws (Amendment)
Ordinance 2014, by the President of India Pranab Mukherjee on
December 26,2014.

- IRDA Act was passed upon the recommendations of Malhotra

Committee report (7 Jan,1994), headed by Mr R.N. Malhotra (Retired
Governor, RBI)
o Main Recommendations - Entrance of Private Sector Companies and
Foreign promoters & An independent regulatory authority for Insurance
Sector in India                        
o In April,2000, it was set up as statutory body, with its headquarters at
New Delhi.
o The headquarters of the agency were shifted to Hyderabad,
Telangana in 2001.
Objectives OF
To promote the interest and rights of policy holders.
o To promote and ensure the growth of Insurance Industry.
o To ensure speedy settlement of genuine claims and to prevent frauds
and malpractices
o To bring transparency and orderly conduct of in financial markets
dealing with insurance.

Organisational Setup of IRDA:

IRDA is a ten member body consists of :

o One Chairman (For 5 Years  & Maximum Age - 60 years )

o Five whole-time Members (For 5 Years and Maximum Age- 62 years)
o Four part-time Members (Not more than 5 years)
The chairman and members of IRDAI are appointed by Government of
India.
The present Chairman of IRDAI is Subhash Chandra Khuntia.

Functions And Duties of IRDA:

Section 14 of IRDA Act,1999 lays down the duties and functions of IRDA:

o It issues the registration certificates to insurance companies and

regulates them.
o It protects the interest of policy holders.
o It provides license to insurance intermediaries such as agents and
brokers after specifying the required qualifications and set norms/code
of conduct for them.
o It promotes and regulates the professional organisations related with
insurance business to promote efficiency in insurance sector.
o It regulates and supervise the premium rates and terms of insurance
covers.
o It specifies the conditions and manners, according to which the
insurance companies and other intermediaries have to make their
financial reports.
o It regulates the investment of policyholder's funds by insurance
companies.
o It also ensures the maintenance of solvency margin (company's
ability to pay out claims) by insurance companies.

__________________________________________________________________

Banking Regulation Act :

The Indian banking sector is regulated by the Reserve Bank of India Act 1934 (RBI Act)

and the Banking Regulation Act 1949 (BR Act). The
Reserve Bank of India (RBI), India's central bank, issues various guidelines, notifications
and policies from time to time to regulate the banking sector.

The banking sector in India as we see today developed and evolved in the last decade of the
18  Century. It was in the post-independence period that the government started to get
th

involved in the economic matters of the nation, be it, private individual. India’s independence
marked the end of the Laissez-Faire economy and we marched toward a mixed economic
system as stipulated in the Industrial Policy Resolution of 1948, where the government could
regulate the economic matters. This resulted in a greater involvement of the government in
different economic segments including the finance and the banking sector.

THE ESTABLISHMENT OF RBI

 The establishment of RBI was based on the recommendations of a Royal Commission

on Indian Currency and Finance known as the Hilton Young Commission after
which it was on 1   April  1935 that the Reserve Bank of India was established as the
st

central banking authority in India and was nationalized on 1   January 1948.

st

 Subsequently, in 1949, the Banking Regulations Act was passed which empowered

the Reserve Bank to regulate, control and inspects the banks in India.
 The outlook and guidelines of the RBI were conceptualized by Dr B.R. Ambedkar in
his book “ The Problem of the Rupee- Its origin and its solutions “
 RBI was established with the aim to regulate the issue of bank notes, to maintain
reserves, secure monetary stability and to operate the credit and currency system of
the country. The RBI actually took over from the government the functions so far
being performed by the Controller of Currency and Imperial Bank of India.
 Currently, the Governor of RBI is Mr Urjit Patel and is headquartered at Mumbai. It
has four zonal offices at Chennai, Delhi, Kolkata and Mumbai.

 THE NEED TO NATIONALIZE BANKS IN INDIA :

Despite the presence of a central regulatory authority i.e., the RBI which could control the
banks, except for the State Bank Of India, other banks were owned by private individuals. It
was in the 1960s that Mrs Indira Gandhi; the then Prime Minister initiated the process of
Bank Nationalization. She summed up the objectives of nationalization as “The present
decision to nationalize major banks is to accelerate the achievements of our objectives “

 Some of the objectives were:

  Controlling private monopolies of the banks that were owned by private business houses
and corporate families and to ensure supply of credit to socially desirable sections.

  Reducing regional imbalance as there was a large rural-urban divide it was necessary for
banking to seep into rural areas also.

  Lending credit to priority sectors like agriculture, which was the largest contributor to
national income.
   Developing banking habits in India as the maximum population lived in rural areas and
for the development of the national banking, habits were necessary among such a huge
population.

THE REGULATIONS OVER BANKS IN INDIA :

The Banking Regulation Act of 1949 and the RBI Act 1953 has given the RBI the power to

regulate the banking system. The Indian banking sector is broadly classified into scheduled
banks and non-scheduled banks. All banks included in the Second Schedule to the Reserve
Bank of India Act, 1934 are Scheduled Banks. Some of the regulatory functions of RBI are :

  RBI issues license to commence new banking operations or to open new branches of the
existing banks through the power given to the RBI under the Banking Regulation Act 1949.

 RBI controls the appointment of the chairman, directors and additional directors of banks in
India.

 RBI ensures banks maintain transparency in disclosing any charges that they levy on their
customers and also ensures that money laundering is curbed through its KNOW YOUR
CUSTOMER guidelines that need to be ensured when anyone opens an account with them.

 RBI has its own monitoring procedure and system for audit and inspection on the basis of
“CAMELS” that stands for Capital adequacy, Asset quality, Management, Earning,
Liquidity, System and Control.

 The BANKING REGULATIONS ACT 1949 was passed with the aim of having a specific
Act for Banking companies. Prior to this act, the banking companies were regulated by the
Indian Companies Act, 1913. This comprehensive legislation ensured a minimum capital
requirement to prevent bank failures and it also eliminated cut-throat competition by
regulation the opening of branches and deciding the location of banks. The BR Act has thus
helped in the balanced growth of banks in India and their working also. It has ensured that the
interests of the depositors are safeguarded.

Some of the important provisions of the Banking Regulations act are :

 Section 6 of the Banking Regulations Act describes the business allowed for a
banking company which includes lending, borrowing of money, bonds, etc,
transacting and carrying on every kind of guarantee and indemnity business, etc while
section 8 of the said Act prohibits it to directly or indirectly be a party to any contract
in relation to buying, selling or exchange of goods.
  Section 9 stipulates that a bank cannot hold any property for more than 7 years for the
purpose of settlements of debts or obligations and the power to change this limitation
period is in the hands of RBI.
 According to section 17 and 18, every banking company must generate a reserve
fund out of its earnings after tax and interest. Such reserve amount should be 20 per
cent of such profits mandatorily and at least 3 per cent of the total demand & time
liabilities should be kept as cash reserve or should be secured in current account with
Reserve Bank of India. Such amount should be deposited/ kept on last Friday of every
2nd fortnight of every month. The return should be deposited before the twentieth day
of every month stating the particulars of the amount deposited to Reserve Bank of
India.As of June 6th, 2018, the Cash reserve ratio ( CRR) was 4% and Reverse Repo
Rate was 6.00%.
 Section 29 describes the plan balance sheet and profit & loss account that should be
complete on last working day of every accounting year in the forms set out in the third
schedule. Accounts must be signed by at least three directors where a number of
directors exceed three. If a number of directors’ fall short of three, then all directors
must sign the accounts. In case of a banking company incorporated outside the nation,
accounts must be signed by a principal officer or manager of the company in India.
 Auditing of Banking Company is described in section 30, which must be done by a
person qualified under law to discharge his duties as an auditor who can only be
removed after the approval of RBI. If not satisfied, it can give orders for carrying out
a special audit at the cost of the bank itself.

 ARE THERE BANKS WHICH DO NOT COME UNDER RBI?

 Yes. There are some banks which do not come under the regulations of the RBI. They are :

 PRIMARY AGRICULTURE SERVICE CO-OPERATIVE BANKS:

These banks accept deposits and lend loans to members only.
 LAND DEVELOPMENTS BANKS:
These banks give long-term loans and are exempted by RBI

 REPCO BANK LTD:

Formed under Govt. Act for Repatriates is not regulated by RBI
 STATE BANK OF SIKKIM:
Deemed as treasury bank of Sikkim is also exempted from RBI

HOW DOES RBI ENSURE COMPLIANCE BY BANKS?

Every bank in India has to comply with the norms set by the RBI which are legal obligations
that have to be abided. To ensure the compliance RBI has various departments which work in
their specific fields and ensure the proper functioning of the economic activities.

 BFS (Board of Financial Supervision) which suggests new reforms and is the main guiding
force behind RBIs regulatory and supervisory initiatives since 1994.

1. DBOD (Department of Banking Operations and Development) frames regulations

for commercial banks in India.
 2. DBS (Department of Banking Supervision) supervises commercial banks including
local area banks and all India financial institutions. It controls the audit and inspection
of banks.
3. DNBS (Department of Non-Banking Supervision) regulates and supervises the
Non-Banking Financial Companies and their audit.
4. UBD (Urban Banks Department) to regulate urban cooperative banks.
5. RPCD (Rural Planning and Credit Department) regulates regional rural banks and
they are supervised by NABARD.

RBI appoints Senior Chartered Accountants as statutory auditors to audit Annual Returns.
Besides RBI officers audit various commercial Bank branches once a year as well as their
controlling offices.

WHAT IF BANKS FAIL TO COMPLY?

 It is very difficult for commercial banks for non-complying guidelines of the

regulator. RBI ensures control over banks through its quantitative (policy rate) and its
qualitative (moral persuasion) measures.
 RBI has the power to impose a penalty, revoke license and monitor frauds in banks.
Banks submit control returns and reports to RBI on weekly, fortnightly, monthly,
quarterly, half-yearly and annual basis regularly.
 Banks submit their annual reports to the Central Government complying with various
RBI guidelines. Control of Non-Profitable Assets and maintaining adequate capital in
banks are ensured on the basis of RBI guidelines.
 If any bank seriously fails in maintaining the standard, banks can be merged,
amalgamated with bigger banks or even closed by RBI. Apart from this, any big or
small default attracts fine or even cancellation of the license.

CONCLUSION :

The importance of banking in modern economy of any country is sufficiently great to justify
a special banking law for its regulation and a special central authority. Banks are custodians
of public’s savings and no government can look upon with equanimity, the misdirected
activities of such banking institutions which exercise a very powerful influence on the
economic activities of the country. Along with the deposit function of the banks, they have a
unique power to create credit which makes the banking sector such a formidable sector that it
is subject to formal control and banking regulations.

Mr. B.T. Thakur , in his book “ Organization of Indian Banking “ clearly mentions the fact
that the total effect of wide range of activities that Reserve Bank of India took since
independence was generally to bring about expansion in the scope of operations of credit
institutions, expansion in scale of financing, expansion of the services and flexibility in
procedures and techniques. In the long run Expansion of developmental activities adversely
affected the regular activities of the Reserve Bank. Therefore, it would have been better if the
bank was not burdened with far too many functions so that it could have time as well as the
independence for dealing with the basic monetary problems of the country.
Though RBI’s policies were never above criticism its role in the post-independence period is
commendable in uplifting the Indian economy by helping the government of the day with
funds to meet the plan need and also expanding and strengthening the banking system as an
institution providing agricultural credit or credit for any other purpose.