The Reserve Bank of India has cut the repo rate and the cash reserve ratio by 25 basis points each. The new effective repo rate for the third quarter is now fixed at 7.25 per cent while CRR stands at 4 per cent.
The cut in CRR is likely to inject Rs 18,000 crore into the system, increasing liquidity in the markets. The reduction in the repo rate has effectually reduced the reverse repo rate down to 6.75 per cent.
The reduction, the first in over nine months, has been largely on expected lines as banking experts and the Finance Ministry had expressed concern over contracting industrial output and falling growth. While the rate cuts may bring a smile to the finance ministry and stock markets, let us take a look at how it can impact the common man with respect to loans and term deposits.
Understanding repo rate and CRR: The rate at which the Reserve Bank of India lends money to commercial banks is known as the repo rate, while CRR is the portion of bank deposits that all commercial banks have to deposit with RBI.
The impact of rate cuts: Although inflation was a deterrent, the cut in repo rate is good news as it is likely to lower the cost of borrowing for both individuals and corporates. The reduction in CRR is likely to improve the availability of funds bringing in more liquidity to the system. Several banks have already lowered their base rates.
The CRR cut is also likely to have a long-term impact on the interest rates on deposits. While repo rate and CRR cut may bring down home and auto loans in the near future, once the banks implements the RBI policy the fixed deposit rates are also likely to go down.
But prior to this move, ICICI Bank and Axis Bank had increased their deposit rates by 25 basis points effective from January 26 and January 24, respectively. Although the banks have announced that the increase is only for longer tenures and with an intention to correct the gaps in their asset-liability growth, there remains a doubt on whether banks will reduce lending rates. So, in effect the tone of the new policy seems neutral. It is assumed that unless the deposit growth gathers momentum or credit growth has a moderate transmission, the net effect of rate cut will be neutral.
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