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.

Banks' reserve rate raised again in China

Just as we approach the credit policy of our country today, the Central Bank of China raised the amount that lenders must hold in reserve by 0.5 percentage point for the sixth time this year.

The increase in the banks' reserve requirement ratio will take effect from August 15, the People's Bank of China, the central bank, said in a statement on its website.

The ratio will reach 12 percent for big lenders after the adjustment.
The move is not all surprising after the release of macroeconomic data for the first half of this year.

Boosted by ample liquidity, China registered gross domestic product growth of 11.5 percent for the first six months, during which fixed-asset investment rose by 25.9 percent. Lending grew by 16.5 percent year on year.

The central government has vowed to prevent the economy from overheating; and the central bank said the hike in the reserve requirements was aimed at "strengthening management of liquidity in the banking system and control excessive growth in money supply and credit".

This act by the Chinese regulators adds yet another point to be considered by the RBI in their credit policy as explained in RBI credit policy on 31st July

RBI credit policy on 31st July

The next RBI credit policy is on 1st August. This is possible the most defining momement in the economic history our our country. The recent events are making the outcome of the credit policy very interesting and is keeping everyone guessing (Related news at RBI may not change rates, inflation under watch and Corporates foresee fall in rates: Survey ). Here are a few events that have to be considered by the RBI

1. The month of July witnessed USD 5 Billion invested in our stock market by Foreign Institutional Investors (FII).

2. The stock market cracked over 550 points in one day on 2th July following concerns on the corrections in the international markets led by the US. Read more and related news at Markets likely to correct further next week

3. The Indian Ruppee cracked 17 paise to move from Rs 40.34 to a US dollar to 40.51 causing a fair bit of appreciation for a single day.

4. India Inc growth at 5-quarter low - Read related news at India Inc growth at 5-quarter low

5. Crude prices soar above 77 dollars a barrel - Read related news at Crude prices soar above 77 dollars a barrel

Meanwhile, the banks have started decreasing their interest rates for their deposits. See related news at Fixed deposits to earn lower interest.... These moves by the banks are causing a fall in the rates offered by FMPs - Are FMPs losing their sheen?