Explained: What is Repo, Reverse Repo, CRR, LAF and Why Are RBI’s Steps Significant

A day after finance minister Nirmala Sitharaman announced a Rs 1.07 lakh crore relief package for the Indian poor in order to help them survive the all-India lockdown due to the Coronavirus pandemic, it was the Reserve Bank of India’s (RBI’s) turn on Friday to do its bit for the banking and finance sector of the country.

RBI governor Shaktikanta Das announced a 75 basis points cut in the benchmark repo rate along with a host of other measures in order to infuse liquidity in the system. During his address, Das made a number of announcements concerning CRR, LAF, reverse repo, etc. Here’s look at what these terms mean and how are they significant for the Indian economy:

Repo rate

RBI’s monetary policy committee (MPC) has cut repo rate by 75 basis points to 4.4% versus 5.15% earlier. The repo rate, or the repurchase rate, is the rate at which RBI lends money to banks when banks face shortage of funds.

When RBI cuts the repo rate, banks get money at a cheaper interest rate, the benefit of which is usually passed on to borrowers – individuals, industries or institutions. Hence, cutting repo rate effectively means cheaper home loans, auto loans or any other kind of borrowings. However, a cut in repo rate also leads to lower interest rate on fixed deposits and other savings instruments.

Reverse repo

The central bank on Friday reduced reverse repo rate by 90 bps to 4%. As the name suggests, reverse repo is like an opposite to repo. Reverse repurchase rate is the rate at which RBI borrows money from commercial banks. It is an instrument which can be used to control the money supply in the country.

A decrease in reverse repo rate means that commercial banks will get less interest rate on parking funds with the central bank, thereby pushing them to move the money in the market to earn more. The RBI governor said on Friday that cut in reverse repo rate was more so that banks are “incentivised to lend” and “disincentivised to hoard money”.

CRR

Cash Reserve Ratio (CRR) was cut by 100 bps to 3% with effect from 28 March 2020. Under CRR, banks have to set aside a certain percentage of the total deposits in the current account with RBI. This means banks do not have access to that amount for any kind of economic or commercial activity and they don’t earn anything on that.

A sharp cut of 100 basis points in CRR basically means that now banks will have to block a lower proportion of their deposits with RBI, and the more money can be diverted to boost credit. This way, they can earn more profit by converting more of non-income bearing deposits into income-earning loans.

LAF

Liquidity adjustment facility (LAF), also known as the liquidity corridor, essentially indicates the difference between the repo rate and the reverse repo rate. The RBI on Friday widened the liquidity corridor, or basically increased liquidity, by cutting reverse repo rate (down 90 bps) by a sharper number than the repo rate (down 75 bps) in order to stimulate the economy and encouraging institutions to borrow.