Banking terms you should know

Steps taken by the Reserve Bank of India have a bearing on financial calculations of banks in the country, consequently affecting the daily life of citizens as well. Recent reduction in repo rates by 25 bps or 0.25% by the RBI has made headlines across the nation. It is the second consecutive time that RBI has cut down repo rates.

For many of us, these banking terms may sound Latin, in spite of them being very important factors even in our day to day lifestyle. Let us take a look at what some of these terms mean.

bps

It is an acronym for “Basis Point”. Basis Point is a unit that is equal to 1/100th of 1%, i.e. 0.01% = 1 basis point. The relationship between percentage and bps is demonstrated as: 1% change = 100 basis points, and 0.01% = 1 basis point.

It is used to denote the change in a financial instrument. Usually bps is used in calculating change in interest rates and yield of a fixed income security. If we say that interest rate is being increased by 1%, it means that it has gone up by 100 bps.

Repo rate

Repo rate is the repurchase rate at which banks borrow money from the central bank of a country (in case of India, the RBI). The banks borrow money from RBI for a short period of time in exchange of selling their securities. An agreement is reached between the banks and RBI that the banks would repurchase their financial assets in future at a pre-determined amount.

Here the borrowing involves spot sale of securities to the lender and also involves forward contract which ensures repayment of the loan to the lender and return of the borrower’s collateral (financial assets). Increase or cut in repo rate takes place as per the discretion of RBI. Repo rate has been reduced from 7.75 to 7.50 by RBI.

Bank rate

Bank rate is the rate at which banks borrow money from the central bank without any sale of securities. Usually the bank rate applies when the loan is taken from the central bank for a longer period of time. Hence, it differs from repo rate in the sense that in case of the bank rate the loan is taken for a longer period of time and there is no sale of security instruments involved.

Both bank rate and repo rate are being determined by RBI on the basis of the demand and supply of money in the country. The current bank rate stands at 8.50% which has been recently reduced from 8.75% by RBI.

Reverse repo rate

Reverse repo rate is the rate at which the central bank borrows money from the other banks for a short duration. Reverse repo rate is applied when banks deposit their short term excess funds with the central bank and earn interest on it.

Reverse repo rate is increased by RBI to curb liquidity in the economy. If RBI feels that there is excess money in circulation in market, then the reverse repo rate is increased, in a bid to arrest inflation. Reverse repo rate stands at 6.5% as of today.

Cash Reserve Ratio (CRR)

Banks cannot utilise all the money deposited by you for lending purpose. There is a certain amount that the banks are required to keep as cash with RBI. The portion which the banks are required to retain with RBI is called CRR.

If you deposit Rs. 100 with a bank and the CRR is 6%; it implies that the banks need to retain Rs 6 of the amount with themselves and they cannot utilise the amount for lending/investment purpose. This amount is deposited with RBI.

RBI increases the CRR in order to control the inflation in the market. An increase in CRR would mean that the banks would be able to give away less loans to consumers, thus constricting the supply of money. Currently, CRR stands at 4%, which has been reduced from 4.25%.

Statutory Liquidity Ratio (SLR)

Statutory Liquidity Ratio implies the amount of money that the banks need to keep with themselves. Banks need to maintain a minimum percentage of deposits with them at the end of every business day. It may be in the form of cash, bonds, gold, etc.

RBI increases the SLR to arrest the inflationary pressure on the economy. If the banks are to maintain higher amount with themselves, then there would be less money in circulation in the market. At present, SLR stands at 23%.

Related Real Estate Articles:

Buying an under construction property? Here are some loan facts

Reverse mortgage as a retirement plan

Buying a house? Get a home loan from bank

Image courtesy of thaikrit at FreeDigitalPhotos.net