Bank Rate, Repo rate and CRR/SLR

Intro to the Bank Rate of RBI : Section 49, The Reserve Bank of India
Act, 1934

The Bank [RBI] shall make public from time to time the standard rate at which it is
prepared to buy or re-discount bills of exchange or other commercial paper eligible
for purchase under this Act.

Discounting Example

Origin of Trade Bill

Sells Shirts on Credit

Exporter Importer

Trade Bill maturing in

6 months

Exporter needs money now to start work on new order. She goes to the Bank

Discounting

Trade Bill maturing in

6 months
Exporter Bank

Cash = The Value of the bill

Discount Discounting Fee

Discount = Interest rate remaining between the date of discounting and the date of maturity
Rediscounting by RBI: Bank wants money to lend more, does not want to hold on to the trade bill

Trade Bill maturing in

6 months
Bank RBI

Cash = The Value of the bill

Discount Bank Rate

The terms Discounting versus Purchase of bill are often use synonymously by Banks and RBI with
some differences in procedural details.

Historically RBI had multiple Bank Rates (until 2004) , sector specific rates which were rarely changed,
deposit and lending rates were changed without changing the Bank rate throughout 1970s . So Bank
Rate was not very effective as a policy instrument and lost its significance as the key policy rate
providing policy signal further since few banks were using it to get re-finance; using overdrafts or other
financing facilities (they we relatively cheaper).

Repo Rate: Associated with the Liquidity Adjustment Facility provided by RBI to Banks.

Repo transaction:

G-Sec (other approved

securities)
Bank RBI

Repo Loan (over - night), 7,

14 or 28 days

After completion of maturity

Repay Loan
Bank RBI

G-Sec (other approved

securities)
Repo rate forms the Ceiling for call money rate as Banks can access short-term liquidity from RBI instead of call
money market. Banks can also park short-term surplus funds with RBI using Reverse Repo (opposite of Repo
transaction). Reverse Repo rate forms the floor for call money rate since the bank with excess liquidity can put the
excess short-term liquidity in Reverse-Repo instead to lending it out through call money market.

CRR : Commercial Bank has total Demand and Time Liability (mainly their Demand and Time Deposits) 0f say INR
100 Cr. And Assets to the Banking System of INR 5 Cr. (Loans and Deposits with other banks). Net Demand and
Time Liabilities are 100 Cr. 5 Cr. = 95 Cr. RBI specifies from time to time what all needs to be included I liabilities
and assets. To satisfy the CRR requirements commercial banks need to keep a specified percentage of these Net
Demand and Time Liabilities (say 4 % = 95Cr.*0.04 = 3.7 Cr.) as Cash Deposits in their account with the RBI. Higher
CRR means less free reserves with banks to give loans.

SLR. Over and above the CRR requirements, commercial banks are required to keep a certain percentage of the
Net Demand and Time liabilities (95 Cr. In the above example) in the form of cash, Gold, or Approved Securities
(mainly G-Sec). So in the above example if SLR is 21 % , banks will have to maintain 0.21*95 Cr. = 19.95 Cr. Of their
Assets In the form of cash, gold or approved securities. Higher SLR reduces the amount of Free securities banks
have to access credit through LAF or other sources.

For details of maintaining SLR/ CRR check out the Master Circular by RBI on guidelines for measuring SLR/ CRR
posted on Moodle under Topic 2.