7 PM | What the RBI has done| 29th March 2020

Good Evening Friends

We are posting Today’s 7pm editorial Summary

About 7pm Editorial Summary – This initiative provides an in-depth analysis of the important news editorial of the day. Students don’t need to look anywhere more for their daily news analysis. We take the most important editorial of the day and provide its comprehensive summary. 

For old Archives of 7pm editorial Summary, Click on “Archives”

7pm Editorial Archives

Context: Draft Competition

Context: Steps taken by RBI to boost banking sector liquidity amid COVID-19 pandemic.

The RBI brought forward its Monetary Policy Committee meeting that was scheduled to start March 31 and in the process joined in delivering surprise actions such as those by the Federal Reserve and other central banks to stem the economic fallout of the pandemic.

This brings us to the questions of RBI governor’s ‘Bazooka’ announcement. In this article, we will explain the below:

  • What are the steps taken by RBI?
  • What is Repo Rate?
  • What is Reverse Repo Rate?
  • What is Cash Reserve Ratio?
  • What is Marginal Standing Facility (MSF)?
  • How lock-down slows down the economy?
  • What would be the likely impact of these steps?
  • Conclusion

[read more]

What are the steps taken by RBI?

  • To keep the wheels of the economy turning, the RBI has taken four key steps:
    • increase the liquidity in the system
    • make sure the lower policy rate is transmitted
    • give a three-month window for a payback on all term loans
    • take steps to reduce volatility and provide stability.
  • Injecting Liquidity: The Reserve Bank of India (RBI) went all out to make ample liquidity available in the market and nudge banks to aid the productive sectors of the economy, announcing measures to inject ₹3.74 trillion.
  • The measures include targeted long-term repo operations (TLTRO) of up to ₹1 trillion.
  • Cut in CRR: The RBI also cut the Cash Reserve Ratio, the amount of deposits lenders must set aside as reserves, by 100 basis points to 3% to boost liquidity.
  • The minimum daily requirement of CRR maintenance has been brought down to 80 percent from 90 percent.
  • Repo Rate: RBI announced a massive 75 basis points cut in repo rates as a measure to counter the economic slowdown caused by the COVID-19 pandemic.
  • Reverse Repo Rate: The central bank also reduced the reverse repo rate by 90bps to 4%, making it less attractive for banks to simply park money with the RBI instead of lending.
  • RBI said the CRR cut and easier MSF rules will infuse ₹1.37 trillion each. With a total Rs 374,000 crore pumped into the system, the RBI actions will significantly help liquidity easing in the system.

What is Repo Rate?

  • Repo rate is the rate at which the central bank of a country lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.
  • In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in arresting inflation.
  • The central bank takes the contrary position in the event of a fall in inflationary pressures. Repo and reverse repo rates form a part of the liquidity adjustment facility.

What is Reverse Repo Rate?

  • Reverse repo rate is the rate at which the central bank of a country borrows money from commercial banks within the country.
  • It is a monetary policy instrument which can be used to control the money supply in the country.
  • An increase in the reverse repo rate will decrease the money supply and vice-versa, other things remaining constant.
  • An increase in reverse repo rate means that commercial banks will get more incentives to park their funds with the RBI, thereby decreasing the supply of money in the market.

What is the Cash Reserve Ratio?     

  • It is that ratio of the total deposits of a bank which it has to necessarily keep with the central bank at a given point of time.
  • RBI is empowered to vary the CRR between 3% and 15%.
  • CRR is used for liquidity management and a monetary tool to regulate money supply.
  • A high CRR reduces the cash for lending and a low CRR increases the cash for lending.
  • The CRR has been brought down from 15% in 1991 to 4% in 2019.

What is the Marginal Standing Facility (MSF)?

  • Marginal standing facility (MSF) is a window for banks to borrow from the Reserve Bank of India in an emergency situation when inter-bank liquidity dries up completely.
  • Banks borrow from the central bank by pledging government securities at a rate higher than the repo rate under liquidity adjustment facility or LAF in short.
  • The MSF rate is pegged 100 basis points or a percentage point above the repo rate. Under MSF, banks can borrow funds up to one percentage of their net demand and time liabilities (NDTL).

How lock-down slows down the economy?

  • Rush to safety for money: If people are in a lock-down, the wheels of the economy begin to grind down and there is a rush to safety for money in the system.
  • Freezing of the markets market: Investors begin to redeem their shares, bonds and mutual funds. These redemptions cause a fire sale of assets. Finally, when there are no buyers, markets begin to freeze.

What would be the likely impact of these steps?

  • Impact of cut in rates of Repo and Reverse repo:
    • When the repo rate is high, banks find it costly to borrow and in turn raise the price of loans to their borrowers. A low repo rate has the overall effect of reducing interest rates for the system.
    • Lower rates make it easier for entrepreneurs to take loans for working capital and for households for homes, vehicles and so on.
    • Cut in Reverse Repo has been done to make it unattractive for banks to passively deposit funds with the RBI and instead lend it to the productive sectors.
    • Bank lending provides the needed oxygen to businesses for their working capital and longer-term loans.
  • Why CRR and not SLR was reduced?
    • There is another 18.25% of deposits that is also not used for lending under the Statutory Liquidity Ratio (SLR), further reducing the money banks have to lend.
    • RBI has reduced the CRR to 3%, freeing up ₹1.37 trillion for banks to lend. CRR has been chosen rather than SLR because this increases ‘primary liquidity’ with the banks a bit better.
    • Not only is there CRR rate down, banks now needs to maintain 80% of the limit on a daily basis instead of 90% till June 26, 2020.
  • Use of Targeted long-term repo operations (TLTRO):
    • RBI will lend money to banks (a total of ₹1 trillion) that can be invested in bonds and other forms of lending instruments.
    • These investments will not be considered under the mark-to-market (MTM) system but under the held-to-maturity classification.
    • It means that the MTM road values the bonds at the price they get in the market today, but when markets are in distress the prices could be wrong or not available.
    • Under the hold-to-maturity way, the portfolio is valued not on the market price but on what the price should be given the rate of interest of the bond, the holding period and the rating of the bond. Basically, it allows trades to happen at a price that is not confused with the current pandemic in the market.
  • Regulatory forbearance:
    • It means that, as economic activity grinds to a slowdown, people will not be able to pay back the loans they have taken for no fault of theirs.
    • This could be businesses with loans, households with EMIs on home loans and others with what are called ‘term loans’.
    • RBI will allow a moratorium of three months for loan repayment.
    • This is a relief especially for small entrepreneurs who have been forced to shut shop and for employees whose incomes have stopped since their place of work is shut.
  • Reducing volatility in the exchange rate:
    • There is a measure to reduce the volatility of the price of the rupee in international markets by allowing banks to deal in off-shore non-deliverable rupee derivative markets.
    • It looks like reform using the crisis to bring about this long-awaited change.

Conclusion:

Life in the time of Covid-19 has been one of unprecedented loss and isolation. Yet, it is worthwhile to remember that tough times never last; only tough people and tough institutions do. A war effort has to be mounted and is being mounted by RBI to combat the virus, involving both conventional and unconventional measures in continuous battle-ready mode.

Source: https://www.livemint.com/opinion/columns/expense-account-what-the-rbi-has-done-in-english-11585296920949.html

[/read]

Print Friendly, PDF & Email

Free IAS Preparation by Email

Enter your email address to subscribe to the blog followed by several Rankholders and ensure success in IAS.