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LESS RATE OF INTEREST ON LOAN

We have heard recently that Mr. Rajan has reduced Repo Rate by 50 basic points and everyone is saying that this is good for the market. Loan EMI may also come down.What is this rate cut means actually? www.333acre.com professionals want to understand this. To understand this you all first need to know, How does a bank function. Now you all think whats a need to know the answer of this question Because All these are interrelated.First of all let us explain what does a bank do? Bank take money from depositors and give loan to earn interest. That way they keep everyone happy and make a profit also. But there are more to it. Let us explain this in a very simplistic way. Bank needs money. Bank can get money from depositors like you and me and also from RBI. Let us try to understand first what happens when we deposit, say, Rs. 100 with a bank. You all know a simple calculation that Bank gives that Rs. 100 to someone who needs a Loan. No it is not that simple. Remember, though bank can earn interest by giving away loans, But it is also very risky. There are many cases of loan defaults. This way bank can put all our money into high risk areas. It has to be protected. RBI has made it mandatory that upon receiving, say, Rs. 100- Bank first have to deposited Rs. 4 with RBI. RBI keeps this Rs. 4 in its current account and hence bank do not receive any interest on this money. This is known as Cash Reserve Ratio or CRR, which is currently at 4%.Then RBI has also made it mandatory that upon receiving, say, Rs.-100- Banks need to compulsorily buy central and state government securities of Rs. 21.50. Of-course bank will earn some interest income here. This is known as Statutory Liquidity Ratio that is SRL, which is currently at 21.50%. In other words Upon receiving Rs.-100, Bank can spend only Rs. 74.50 at its own will. Illustration : 100 - 4 (4 + 21.50) = 100 - 25.50 = 74.50 But we told you one thing also that Bank can also borrow from RBI. Do you know What interest bank pay to RBI? Before 30th September 2015, Banks were paying 8.25% interest to RBI when it borrows money from RBI. Now this rate has been reduced by 50 basic points. So bank now need to pay interest to RBI, if it borrows from RBI, at the rare of 7.75%. This is known as Repo Rate. Fixed Deposite rate also affected by reduction of Repo Rate. If bank get money from RBI @ 7.75%, why will bank pay higher interest to you and me ? 333Acre wants to tell you that one year FD rate is already revised by many banks and it is equal to or very closed to 7.75% . But as now banks are getting money at a cheaper rate, then they should reduced the loan interest rate i.e passing on the benefits it receives. And They should be. And on that Hope market is cheering. If companies get loan at a cheaper rare, they will likely to expand their businesses. That will create more jobs, more income, more infrastructure , more developments and boost the economy. Inflation is also linked to this. Because when loans becomes cheaper, people tends to borrow more. That means people will have more money to spend. This will increase the demand for goods , services, property and if supply does not increase to match this demand, then prices will increase. So there is a chance , that inflation may also rise. But inflation depends on many other factors as well, like production - Industrial and Agricultural , manufacturing, export- import, foreign currency movement etc. So inflation may increase or may not. Do you know Like we deposit our money with banks. Banks also deposit their money with RBI and earn interest too. This interest is typically 1% less than the Repo rate. This rate is known as Reserve Repo rate. So Now you all can understand CRR, SLR, Repo Rate, Reserve Repo Rate and their impact on deposite rate, loan interest rate and on inflation. Jaya Sharma www.333acre.com

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04 Oct 2015

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