Banking Awareness 2017 – Important Tools & Rates of RBI – MCLR | Repo Rate | Monetary Policy


Hello and welcome to exampundit. So here are the Important tools and rates of RBI used in the economy and banking sector.

Repo Rate and Reverse Repo Rate
Repurchase Options or in short Repo, is a money market instrument,
which enables collateralised short term borrowing and lending through
sale/purchase operations in debt instruments. This is an instrument used by the
Central Bank and banking institutions to manage their daily / short term
Legally it is
repo” means an instrument for borrowing funds by selling
securities with an agreement to repurchase the securities on a mutually agreed
future date at an agreed price which includes interest for the funds borrowed;
reverse repo” means
an instrument for lending funds by purchasing securities with an agreement to
resell the securities on a mutually agreed future date at an agreed price which
includes interest for the funds lent.”
This is the general definition of
Repo and Reverse Repo in India
. The securities transacted here can be either
government securities or corporate securities or any other securities which the
Central bank permits for transaction. Non-sovereign securities are used in many
global markets for repo operations. Unlike them, Indian repo market
predominantly uses sovereign securities, though repo is allowed on corporate
bonds and debentures.
The Repo transaction, as adopted
in India, has two legs:
– in the first leg seller sells securities and receives
cash while the purchaser buys securities and parts with cash. In the second
leg, securities are repurchased by the original holder. He pays to the counter
party the amount originally received by him plus the return on the money for
the number of days for which the money was used by him, which is mutually
agreed. All these transactions are reported on the electronic platform called
the Negotiated Dealing System (NDS).
Types of Repos based on

There are basically four types of
repos based on its maturity period.
  1. Overnight refers to repos with a
    single-day maturity
    (eg. Additional repos conducted in the Indian market on the
    reporting Fridays (i.e., the Fridays on which banks have to report to RBI on
    the fortnightly position on CRR and SLR). Indian Repo market is
    predominantly an overnight repo market.
  1. Term Repos refers to repos that
    have a fixed maturity longer than one day
    . If the period is fixed and agreed in
    advance, it is a term repo, where either party may call for the repo to be
    terminated at any time, though it may require one or two days’ notice.

Market Stabilization Scheme

Market Stabilization scheme (MSS)
is a monetary policy intervention by the RBI to withdraw excess liquidity (or
money supply) by selling government securities in the economy
. The MSS was
introduced in April 2004. Main thing about MSS is that it is used to withdraw
excess liquidity or money from the system by selling government bonds.
When MSS is to be used?
MSS is used when there is high
liquidity in the system.
What securities to be sold under

           The issued securities are government
bonds and they are called as Market Stabilisation Bonds (MSBs). Thus, the bonds
issued under MSS are called MSBs. These securities are owned by the government
though they are issued by the RBI.

The securities or bonds/t-bills
issued under MSS are purchased by financial institutions. They will get an
interest for purchasing the securities. 

 Statutory Liquidity Ratio
The Statutory Liquidity Ratio
(SLR) is a prudential measure under which (as per the Banking Regulations Act
1949) all Scheduled Commercial Banks in India must maintain an amount in one of
the following forms as a percentage of their total Demand and Time Liabilities
(DTL) / Net DTL (NDTL);
[i] Cash.
[ii] Gold; or
[iii] Investments in
un-encumbered Instruments that include;
(a) Treasury-Bills of the
Government of India.
(b) Dated securities including
those issued by the Government of India from time to time under the market
borrowings programme and the Market Stabilization Scheme (MSS).
(c) State Development Loans
(SDLs) issued by State Governments under their market borrowings programme.
(d) Other instruments as notified
by the RBI.

SLR rate = (liquid assets / (demand + time liabilities)) × 100%


  • to control the expansion of bank credit. By changing the level of SLR, the Reserve Bank of India can increase or decrease bank credit expansion.
  • to ensure the solvency of commercial banks.
  • to compel the commercial banks to invest in government securities like government bonds.

If any Indian bank fails to maintain the required level of Statutory Liquidity Ratio, then it becomes liable to pay penalty to Reserve Bank of India. The defaulter bank pays penal interest at the rate of 3% per annum above the Bank Rate, on the shortfall amount for that particular day. But, according to the Circular, released by the Department of Banking Operations and Development, Reserve Bank of India; if the defaulter bank continues to default on the next working day, then the rate of penal interest can be increased to 5% per annum above the Bank Rate. This restriction is imposed by RBI on banks to make funds available to customers on demand as soon as possible. Gold and government securities (or gilts) are included along with cash because they are highly liquid and safe assets.

Both Cash Reserve Ratio (CRR) and SLR are instruments in the hands of RBI to regulate money supply in the hands of banks that they can pump into the economy.

Traditionally the amount to be
held thus was stipulated to be no lower than 25 percent and not exceeding 40
percent of the bank’s total DTL. However, effective from January, 2007 the
floor of 25 percent on the SLR was removed following an amendment of the
Banking Regulation Act, 1949
Liquidity Adjustment Facility (LAF)
LAF is a facility extended by the
Reserve Bank of India to the scheduled commercial banks (excluding RRBs)
primary dealers to avail of liquidity in case of requirement or park excess
funds with the RBI in case of excess liquidity on an overnight basis against
the collateral of Government securities including State Government securities.
Basically LAF enables liquidity management on a day to day basis.
Liquidity adjustment facility (LAF) is a
monetary policy tool which allows banks to borrow money through repurchase
agreements or repos.
Marginal Cost of Funds Based Lending Rate
The marginal cost of funds based
lending rate (MCLR) refers to the minimum interest rate of a bank below which
it cannot lend
, except in some cases allowed by the RBI.
It is an internal benchmark or
reference rate for the bank. MCLR actually describes the method by which the
minimum interest rate for loans is determined by a bank – on the basis of
marginal cost or the additional or incremental cost of arranging one more rupee
to the prospective borrower.
Reasons for introducing MCLR

RBI decided to shift from base rate to MCLR
because the rates based on marginal cost of funds are more sensitive to changes
in the policy rates. 

This is very essential for the effective implementation of
monetary policy. Prior to MCLR system, different banks were following different
methodology for calculation of base rate /minimum rate – that is either on the
basis of average cost of funds or marginal cost of funds or blended cost of
Calculation of MCLR

The MCLR is a tenor linked
internal benchmark
(tenor means the amount of time left for the repayment of a
loan). The actual lending rates are determined by adding the components of
spread to the MCLR. Banks will review and publish their MCLR of different
maturities, every month, on a pre-announced date.
Banks may publish every month the
internal benchmark/ MCLR for the following maturities:
  1. Overnight MCLR,
  2. One-month MCLR,
  3. Three-month MCLR,
  4. Six month MCLR,
  5. One year MCLR.

Base Rate
The Base Rate is the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. It is the minimum interest rate of a bank below which it is not viable to lend. The base rate, introduced with effect from 1st July 2011 by the Reserve Bank of India, is the new benchmark rate for lending operations of banks.

Base Rate vs MCLR

Base rate calculation is based on
cost of funds, minimum rate of return, i.e margin or profit
, operating expenses
and cost of maintaining cash reserve ratio
while the MCLR is based on marginal
cost of funds, tenor premium, operating expenses and cost of maintaining cash
reserve ratio
. The main factor of difference is the calculation of marginal
cost under MCLR. Marginal cost is charged on the basis of following factors-
interest rate for various types of deposits, borrowings and return on net
worth. Therefore MCLR is largely determined by marginal cost of funds and
especially by deposit rates and repo rates.
Cash Reserve Ratio (CRR)
Cash Reserve Ratio refers to the
fraction of the total Net Demand and Time Liabilities (NDTL) of a Scheduled
Commercial Bank held in India
, that it has to maintain as cash deposit with the
Reserve Bank of India (RBI). The requirement applies uniformly to all banks in
the country irrespective of an individual bank’s financial situation or size.
In contrast, certain countries e.g. China stipulates separate reserve
requirements for ‘large’ and ‘small’ banks.
Policy Rate
The policy rate is the key
lending rate of the central bank in a country. It is a monetary policy
instrument under the control of the Central Bank -Reserve Bank of India (RBI)
to regulate the availability, cost and use of money and credit.
A change in the policy rate
alters all other short term interest rates in the economy, thereby influencing
the level of economic growth and inflation. (A low interest rate regime is
considered conducive to growth while it generally fuels inflation)
Interest Rate Corridor
interest rate corridor or a policy corridor refers to the range within which
the operating target of the monetary policy – a short term interest rate, say
the weighted average call money market rate – moves around the policy rate
announced by the central bank. 
Monetary Policy Framework Agreement
Monetary Policy Framework
Agreement is an agreement reached between Government and the central bank in
India – The Reserve Bank of India (RBI) – on the maximum tolerable inflation
rate that RBI should target to achieve price stability.
Monetary Policy Committee (MPC)
The Monetary Policy Committee
(MPC) is a committee of the Central Bank in India (Reserve Bank of India),
headed by its Governor, which is entrusted with the task of fixing the
benchmark policy interest rate (repo rate) to contain inflation within the
specified target level.
Bank Rate
Under Section 49 of the Reserve
Bank of India Act, 1934
, the Bank Rate has been defined as “the standard
rate at which the Reserve Bank is prepared to buy or re-discount bills of
exchange or other commercial paper eligible for purchase under the Act.”
Bank rate is the rate at which
central bank lends money to the commercial banks by buying their eligible rated
securities – bills of exchange or commercial paper.


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