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What is Reverse Repo Rate? Why RBI May Cap Reverse Repo? Why Indian Banks Are Not Lending?

Editor, TRANSFIN.
Apr 21, 2020 6:30 AM 3 min read
Editorial

The RBI has called out banks for parking huge amounts of money within its reverse repo window even as the reverse repo rate has been consistently slashed. The Central Bank is reportedly willing to impose a cap on reverse repo amounts to ensure that liquidity translates to credit. But will this be enough to make banks lend more? We explain what the reverse repo rate is and its implications on bank lending.

 

 

What is Reverse Repo Rate?

Repo rate is the rate at which the Central Bank of a country lends to commercial banks. This is a fairly common monetary policy tool to control inflation and economic growth. The current repo rate in India is 4.4%.

 

Another monetary policy tool, one that is not as well-known, is the reverse repo rate. This is, as the name suggests, the opposite of repo rate – i.e., it is the rate at which commercial banks lend money to the Central Bank. It is a tool the RBI uses to control liquidity in the banking system. Presently, the reverse repo rate in India is 3.75%.

 

Are Banks Overusing the Reverse Repo Window?

Bank lending has plunged in recent weeks. On February 20th, banks had deposited ₹39,983cr ($5.27bn) with the RBI under the reverse repo window. By April 12th, this had exploded to ₹7,01,69cr ($9.25bn), an increase of 1,655%. This means there is less money with banks to loan out to companies and consumers.

 

Speaking of loans, non-food credit grew at its slowest pace in nearly three decades in 2019-20. This includes home loans, auto loans, car loans etc. The number for last year was 6.1%, the lowest since 1993-94 when non-food credit growth was 5.7%.

 

Why Does the RBI Want Banks to Lend More?

RBI Governor Shaktikanta Das has said the recent 25 basis points cut in reverse repo rate is to “encourage banks to deploy these surplus funds in investments and loans in productive sectors of the economy”.

 

The country is in an extended state of lockdown, many sectors of the economy are barely operational, and all ratings agencies are predicting a severe hit to GDP growth this financial year. The economy was already in a prolonged slowdown and the COVID-19 pandemic aggravated matters to boiling point.

 

The Central Bank wants banks to lend more freely rather than park their assets with the RBI. More liquidity and more money given out to consumers could help offset some of the negative consequences of the lockdown. It would place more credit in the hands of firms and people, who could use it for anything from buying essential needs to paying off debts.

 

Why Don’t Banks Want to Lend More?

Lenders seem to be rushing to deposit their excess money with the RBI. In these uncertain times, this seems like a safer bet for banks when compared to loaning it elsewhere (where, by the way, banks would be expected to slash interest rates considering the cuts in repo rate).

 

This translates to lower revenue from loans and the added dangers of more bad loans in coming months. Bad loan ratios remain high especially among public sector banks, whose bad loan rate as of September 2019 was an unenviable 12.7%.

 

Therefore, asking lenders to lend right now is easier said than done. The RBI has already cut the reverse repo rate twice in the last three weeks. Whether this will lead to more money in the system will depend on how quickly consumer demand will pick up and on banks’ confidence on a swift economic turnaround. In fact as per CII, anything less than a partial credit guarantee from the government would come across as a half measure. 

 

FIN.

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