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Why do the markets track RBI rates? Understanding the impact

Dec 27, 2019 | 3 months ago | Read Time: 3 minutes | By iKnowledge Team
Tracking RBI Rates

What is the RBI

RBI is an acronym for Reserve Bank of India as the central bank of India, founded on April 1, 1935, under the RBI Act. The Reserve Bank of India uses monetary policy to create economic balance in India, and it controls the regulation of the country’s monetary and credit operations.

Positioned in Mumbai, the RBI assists the commercial hub in many ways. The bank looks over and controls the overnight interbank exchange rate. The Mumbai Interbank Offer Rate (MIBOR), works as a benchmark for interest rate for financial devices in the country.

The RBI was previously placed as an individual entity but got nationalized in 1949. The Reserve Bank is managed by a central board of directors selected by the government. The directors are elected for four years.

The RBI and Monetary Policy

The RBI forms, implements and controls the country’s monetary policy. The bank administration’s objective is to maintain cost stability and ensure that money is flowing at a steady rate. The RBI also handles all foreign trades under the Foreign Exchange Management Act of 1999. This act helps the RBI to promote external trade and payments, to encourage the growth and well-being of the foreign exchange market in the country.

The RBI behaves as a regulator and executive of the entire financial system. This function carries people’s confidence in the national economic policy, guards interest movements and provides solid banking choices to the public. Eventually, the RBI is the one that issues the national currency. It means that money is either released or impaired depending on its spell for current rotation. This spell provides the Indian citizens with a supply of money in the form of trustworthy notes and coins.

Why do the markets track RBI rates?

The RBI has different tools to control and manage the flow of money in the market. Two among them are the Cash Reserve Ratio and Repurchase rate.

Cash Reserve Ratio (CRR): It is the ratio of collaterals banks must maintain by the RBI. It means that if an individual deposit Rs 10,000 in his bank, the bank might use it to invest in others, but because of CRR, it must store a fraction of that amount to the RBI. Therefore, if the CRR is 5 per cent, the bank will provide Rs.500 to the RBI and holds INR 90,500 left. CRR rate indirectly controls the economy. Thus, if the CRR were to be increased by only 1 per cent, the cash generation in the market will decrease drastically.

Repurchase Rate (Repo Rate): The repurchase rate (repo rate) is the interest imposed by the RBI to banks when they request for short-term credits. The repo rate relates to the interest borrowers return when they take loans because the bank collects interest, which is higher than the repo rate. Hence, lower repo rates help banks to lower the interest they charge from private borrowers, thereby making loans to be affordable.  

While the repo rate is the interest charged by the RBI on loans granted to other commercial banks, overnight rate is the interest imposed if banks borrow among themselves. When RBI increases the repo rate, the bank’s borrowing prices rise, which reduces the supply of funds in the market, and makes it costlier.

Repo rate and inflation: When the repo rate increases, banks are forced to pay higher interest to the RBI which prompts them to increase the interest in loans they offer to consumers. In such a scenario, the customers are discouraged from getting a loan from banks, pointing to a deficiency of funds in the economy and less flow of money. So, if inflation is controlled, then there is less money to spend, and the development suffers as businesses dodge loans at high interest, commencing a shortfall in production and development.

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