Layman’s view of Credit Policy - Part 1

This is part 1 of the series where I will try and explain the key terms and the changes that have been made by the Reserve Bank of India (RBI) in the policy announced on July 31.

What is CRR?
Yesterday the RBI increased the CRR from 6.5% to 7%. What does CRR mean and how does it impact you ?. Read on. Indian banks are required to hold a certain percentage of their deposits as cash. This means if you deposit Rs 100 in a bank, they will have to maintain Rs 7 as cash and can only use Rs 93 for their business purpose as against Rs. 93.5 that was available to business earlier(There is something called SLR also, which we will see later on). However, in reality the banks don’t hold these as cash with themselves, but with Reserve Bank of India (RBI), which is as good as holding cash. Thus the RBI uses the CRR an instrument in the hands of a central bank through which it can control the amount by which banks can lend or do business.

The RBI kept unchanged its key rates such as the reverse repo at 6 per cent, the repo rate at 7.75 per cent, and the bank rate at 6 per cent. We will look at these terms at a later point of time.

What does a hike in this rate mean ?
The hike in CRR from 6.5 to 7 per cent will increase the amount that banks have to hold with RBI. It will therefore reduce the amount that they can lend out. The move is expected to shift Rs 16,000 crore of resources that could have otherwise been lent for business to the RBI. In the past few months the money that banks had for giving credit (read as loan to others) was much higher than the amount they have been actually lending out. The objective of the CRR hike is to mop up some of the excess liquidity in the system.

Will this mean a rise in interest rates on my deposits and home loans too? By when and by how much?
The hike in CRR is not likely to lead to an immediate increase in interest rates. There is excess liquidity in the system even after a higher amount is deposited with RBI as reserves. In fact banks have started reducing the deposit rates for 1 year deposits which has reduced from on an aveerage 9.5% to 9% p.a. At the same time, while lending rates may not come down immediately, most bankers feel that the interest rates have peaked out atleast for some time to come.