Today we will see what is CRR rate and Repo rate and how they help in combating Inflation and other monitory issues of Economy .

Read how inflation eats away you purchasing power .

You might know what is CRR or REPO RATE , but may not know what is there significance and how they Help . Read whole article to understand .

What is CRR Rate ?

CRRis simple , Cash Reserve Ratio ! . It is the the ratio of depositswhich banks have to keep with RBI . When you deposit Rs 100 to yourbank , bank gets Rs 100 and now can use this money to lend others , butthey have to put some part of it with RBI , if CRR is 8% , they will have to deposit 8 with RBI and they are left with Rs 92 .

So when CRR is decreased , Banks are left with more money to lend and when its increased they are left with less , even though 1% decrease in CRR leaves bank with 93 instead of 92 , this Rs 1 is big enough thing .

What is Repo Rate ?

Whenyou take loan from some bank you pay interest for that , in the sameway , these banks also take short term loans from RBI , and theinterest RBI charges from them is called Repo rate . So if repo rate is 9% , and some bank takes loan of Rs 100 from RBI , they will pay interest at the rate of 9% .

How is Repo Rate linked to the interest we pay for loans from Bank ?

Simple , Banks need to charge more interest than they are paying , so if repo rate is 8% , they will charge more than 8% for loans which they give , If Repo rate comes down , banks may also consider the interest rate they charge us .

Thats the reason why with this latest Reporate cut , people are talking about home loans rates coming down , sowhat will happen is that Bank need to pay less interest for the loanthey take from RBI , now because they are paying less , they may thinkof charging us less on the interest for the loans which we have takenfrom them .

What is Money Creation ?

Howdo money gets created ? When A gives 100 to B , Rs 100 is created for B, then when he gives this to C , 100 is again created for C , this waymoney creation happens for different people from that same 100 .

How does CRR help ?

Suppose CRRis 8% you had 100 , which you deposit to bank , now bank will Deposit 8to RBI and lend this 92 to some one , This 92 will be another moneywhich is created for someone , now this 92 will exchange hands and thencome back to bank somehow , out of this 92 again bank will deposit 7.36to RBI and then lend the rest of it to someone ... and it goes on likethis

The money creation from this 100 is :

100 + 92 + 84.64 ... (100 + 100*.92 + 100*.92*.92 + 100 *.92 * .92 * .92 ...)
= 100 *( 1+ .92^1 + .92^2 + .92^3 ...)
=100 * (1/(1-.92)) (because 1 + x + x^2 + x^3 ... infinite times =1/(1-x) for x<1) 08 =" 1250" class="blsp-spelling-error"id="SPELLING_ERROR_21">CRR(C) = M/C It means that this 100 actually generates 1250 in the economy indirectly. What will happen if CRRis increased by 1% , from 8% to 9% . though it may looks like that thisis a small change and it would affect a lot .. lets see what happensnow How much money will 100 create now ?

Ans = 100/.09 = 1111 (approx)

So the same money is now generating 1111 instead of 1250 , that's 139 less or 11.12% less money in the market .

How does Repo Rate and CRR help to ease Inflation ?

Repo Rate : When reporate is increased , the banks can have to pay higher interest to govtand they also charge higher interest from common public which gets discouraged to take more credit from banks , because of which there is less supply of money in system and there is less Liquidity ?

CRR : Its easy , if CRRis increased , banks have to deposit more money in with the bank and itresults in less money creation in economy , and hence people have lessmoney to buy things and they will think twice before paying higherprice for something .

So in short Repo Rate and CRRare two tools which RBI uses to control the liquidity in country and asInflation is linked to liquidity , it can be controlled to a greatextent .

Some other articles

What are the 5 most important things for your Portfolio : 5 Elements

What are the most important charecteristics for your portfolio : Pillars or success