Today we will see what is CRR rate and Repo rate and how they help in combating Inflation and other monitory issues of Economy
You might know what is CRR or REPO RATE , but may not know what is there significance and how they Help . Read whole article to understand .
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What is CRR Rate ?
CRR is simple , Cash Reserve Ratio ! . It is the the ratio of deposits which banks have to keep with RBI . When you deposit Rs 100 to your bank , bank gets Rs 100 and now can use this money to lend others , but they have to put some part of it with RBI , if CRR is 8% , they will have to deposit 8 with RBI and they are left with Rs 92 .
So when CRR is decreased , Banks are left with more money to lend and when its increased they are left with less , even though 1% decrease in CRR leaves bank with 93 instead of 92 , this Rs 1 is big enough thing .
What is Repo Rate ?
When you take loan from some bank you pay interest for that , in the same way , these banks also take short term loans from RBI , and the interest RBI charges from them is called Repo rate . So if repo rate is 9% , and some bank takes loan of Rs 100 from RBI , they will pay interest at the rate of 9% .
How is Repo Rate linked to the interest we pay for loans from Bank ?
Simple , Banks need to charge more interest than they are paying , so if repo rate is 8% , they will charge more than 8% for loans which they give , If Repo rate comes down , banks may also consider the interest rate they charge us .
Thats the reason why with this latest Repo rate cut , people are talking about home loans rates coming down , so what will happen is that Bank need to pay less interest for the loan they take from RBI , now because they are paying less , they may think of charging us less on the interest for the loans which we have taken from them .
What is Money Creation ?
How do money gets created ? When A gives 100 to B , Rs 100 is created for B , then when he gives this to C , 100 is again created for C , this way money creation happens for different people from that same 100 .
How does CRR help ?
Suppose CRR is 8% you had 100 , which you deposit to bank , now bank will Deposit 8 to RBI and lend this 92 to some one , This 92 will be another money which is created for someone , now this 92 will exchange hands and then come back to bank somehow , out of this 92 again bank will deposit 7.36 to RBI and then lend the rest of it to someone … and it goes on like this .
The money creation from this 100 is :
100 + 92 + 84.64 … (100 + 100*.92 + 100*.92*.92 + 100 *.92 * .92 * .92 …)
= 100 *( 1+ .92^1 + .92^2 + .92^3 …)
= 100 * (1/(1-.92)) (because 1 + x + x^2 + x^3 … infinite times = 1/(1-x) for x<1) 08 ="1250"
CRR(C) = M/C
It means that this 100 actually generates 1250 in the economy indirectly. What will happen if CRR is increased by 1% , from 8% to 9% . though it may looks like that this is a small change and it would affect a lot . lets see what happens now
How much money will 100 create now ?
Ans = 100/.09 = 1111 (approx)
So the same money is now generating 1111 instead of 1250 , that’s 139 less or 11.12% less money in the market .
How does Repo Rate and CRR help to ease Inflation ?
Repo Rate : When repo rate is increased , the banks can have to pay higher interest to govt and they also charge higher interest from common public which gets discouraged to take more credit from banks , because of which there is less supply of money in system and there is less Liquidity ?
CRR : Its easy , if CRR is increased , banks have to deposit more money in with the bank and it results in less money creation in economy , and hence people have less money to buy things and they will think twice before paying higher price for something .
So in short Repo Rate and CRR are two tools which RBI uses to control the liquidity in country and as Inflation is linked to liquidity , it can be controlled to a great extent .
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{ 17 comments… read them below or add one }
Good one Manish !!! Just amazing always read CRR and Repo Rate didnt understand it or should I say didnt take the effort to understand it:)
Thanks
Nitin
Hey Nitin
Good to know that you understood it well .. People often read and hear about it but cant relate it with market or economy and hence they dont know how it can benefit them …
It may happen that repo rate is decreased significantly , but people who have taken home loans will not ask there banks why they have not slashed the interest rates for loans, because of this ignorance banks may delay the lowering of rates and hence benefit monitorily from the delay .
well.. good to know that readers are understanding what i write …
Manish
Thats a good point you have brought up, we alwayz think to ourselves “Why would bank decrease interest rates if an individual ask, bank is such a big entity they wont care” But the point is if many are knowledgable about such factors such big entities would be on their toes.
Thanks for spreading knowledge.
Nitin
Good One Manish!!
Thanks Sachin …
thanks a lot your explanation help me a lot in my presentation.
Thanks Mansi ..
Good to know that it helped you in your presentation and thansk for leaving the comment ..
What presentation is this .. may be i can know more about the subject and learn ..
Manish
thanks a lott manish…due to this i hv learnt a lott bout all this…nd it helped me in my presentation also..
Welcome
hi manish
i just want u to say alot of thnxxx as i ws strugggling wid this topic as hvng presntatn on dis nd m a biotechnology bk grnd student…bt now i hv undesrstood it well bcoz of u..so thnxx alot
bhawana yadav
@Bhawana
Thanks .. good luck
Manish
Nice Manish, but the discussion will be incomplete if you do not touch SLR and Reverse Repo simultaneously. Also, one more question may come to mind is if out of Rs 100 deposit banks put, say, Rs 8 with RBI and lend Rs 92( which they do not do due to SLR) then what is the need to borrow money from RBI @ Repo.
I would cover it on some article once i get time
Banks some times need short term debt like 1 day or 2 days , then they take it from RBI , then reverse repo rate comes into picture .
I dont think SLR comes into picture anywhere here , Its just a ratio of deposits they need to have as liquid deposits so that there is no liquidity issue .
Manish
Thanks.
Is bare mei pada bahut tha, but funda ab jakar samaj mei aaya hei.
Ab is concept ki nabj pakad mei aa gayee hei.
Thanks a lot.
wah wah .. humari kushnasibi
jo aap ko ye pasand aaya . aate rahiyega , yu hi comments marte rahiyega 
Manish
Hi Manish,
How it can control food inflation ?
Even there will be less money in market due to increase in CRR but people will still buy food to eat.
they have to buy n thy won’t think twice.
I couldn’t digest it.
Regards
Yogesh
it cant exactly control food inflation . food inflation is also a part of overall inflation and all it can do it to help in reducing it . there is no direct relation with it . anyways . .this is little off topic and my knowledge is also limited
Manish