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RBI cuts CRR, SLR, repo; lending and deposit rates to fall

Mumbai (PTI): Home, consumer and corporate loan rates are likely to ease in the near
future, with the RBI on Saturday announcing a slew of monetary measures.
The RBI provided the following details in a press release:
In its Mid-Term Review of the Annual Policy Statement for 2008-09, the Reserve Bank
of India indicated that in the context of the uncertain and unsettled global situation and its
indirect impact on our domestic economy and our financial markets, it would closely and
continuously monitor the situation and respond swiftly and effectively to developments.
In doing so, the Reserve Bank will employ both conventional and unconventional
measures. Global financial conditions continue to remain uncertain and unsettled, and
early signs of a global recession are becoming evident. These developments are being
reflected in sharp declines in stock markets across the world and heightened volatility in
currency movements. International money markets are yet to regain calm and confidence
and return to normal functioning.
It was also indicated in the Mid-Term Review that the current challenge for the conduct
of monetary policy is to strike an optimal balance between preserving financial stability,
maintaining price stability and sustaining the growth momentum. Inflation, in terms of
the wholesale price index (WPI), has been softening steadily since August 9, 2008 and
has declined to 10.68 per cent for the week ended October 18, 2008. Globally, pressures
from commodity prices, including crude, appear to be abating. The moderation in key
global commodity prices, if sustained, would further reduce inflationary pressures. On the
growth front, it is important to ensure that credit requirements for productive purposes are
adequately met so as to support the growth momentum of the economy. Domestic
financial markets have been functioning normally. Prudent regulatory surveillance and
effective supervision have ensured that our financial sector has been and continues to be
robust. However, the global financial turmoil has had knock-on effects on our financial
markets; this has reinforced the importance of focusing on preserving financial stability,
The Reserve Bank has reviewed the current and evolving macroeconomic situation and
liquidity conditions in the global and domestic financial markets. Based on this review, it
has decided to take the following further measures:
(i) On October 20, 2008, the Reserve Bank announced a reduction in the repo rate under
the Liquidity Adjustment Facility (LAF) by 100 basis points from 9.0 to 8.0 per cent. In
view of the ebbing of upside inflation risks as also to address concerns relating to the
moderation in the growth momentum, it has been decided to reduce the repo rate under
the LAF by 50 basis points to 7.5 per cent with effect from November 3, 2008.
(ii) The cash reserve ratio (CRR) of scheduled banks is reduced by 100 basis points from
6.5 per cent to 5.5 per cent of net demand and time liabilities (NDTL). This will be
effected in two stages: by 50 basis points retrospectively with effect from the fortnight
beginning October 25, and by a further 50 basis points prospectively with effect from the
fortnight beginning November 8, 2008. This measure is expected to release around
Rs.40,000 crore into the system.
(iii) On September 16, 2008, the Reserve Bank had announced, as a temporary and ad
hoc measure, that scheduled banks could avail additional liquidity support under the LAF
to the extent of up to one per cent of their NDTL and seek waiver of penal interest. It has
now been decided to make this reduction permanent. Accordingly, the Statutory Liquidity
Ratio (SLR) will stand reduced to 24 per cent of NDTL with effect from the fortnight
beginning November 8, 2008.
(iv) In order to provide further comfort on liquidity and to impart flexibility in liquidity
management to banks, it has been decided to introduce a special refinance facility under
Section 17(3B) of the Reserve bank of India Act, 1934. Under this facility, all scheduled
commercial banks (excluding RRBs) will be provided refinance from the Reserve Bank
equivalent to up to 1.0 per cent of each bank's NDTL as on October 24, 2008 at the LAF
repo rate up to a maximum period of 90 days. During this period, refinance can be
flexibly drawn and repaid.
(v) On October 15, 2008 the Reserve Bank announced, purely as a temporary measure,
that banks may avail of additional liquidity support exclusively for the purpose of
meeting the liquidity requirements of mutual funds (MFs) to the extent of up to 0.5 per
cent of their NDTL. A similar facility of liquidity support for non-banking financial
companies (NBFCs) is also found to be necessary to enable them to manage their funding
requirements. Accordingly, it has now been decided, on a purely temporary and ad hoc
basis, subject to review, to extend this facility and allow banks to avail liquidity support
under the LAF through relaxation in the maintenance of SLR to the extent of up to 1.5
per cent of their NDTL. This relaxation in SLR is to be used exclusively for the purpose
of meeting the funding requirements of NBFCs and MFs. Banks can apportion the total
accommodation allowed above between MFs and NBFCs flexibly as per their business
needs.
(vi) As indicated in the Reserve Bank's press release of September 16, 2008, as on some
previous occasions, the Reserve Bank will continue to sell foreign exchange (US dollar)
through agent banks to augment supply in the domestic foreign exchange market or
intervene directly to meet any demand-supply gaps. The Reserve Bank would either sell
the foreign exchange directly or advise the bank concerned to buy it in the market. All the
transactions by the Reserve Bank will be at the prevailing market rates and as per market
practice. Entities with bulk forex requirements can approach the Reserve Bank through
their banks for this purpose.
(vii) It has been decided, as a temporary measure, to permit Systemically Important Non-
Deposit taking Non-Banking Financial Companies (NBFCs-ND-SI) to raise short- term
foreign currency borrowings under the approval route, subject to their complying with the
prudential norms on capital adequacy and exposure norms. Details in this regard have
been notified separately and are available on the Reserve Bank's web site.
(viii) Under the Market Stabilisation Scheme (MSS), Government Securities (treasury
bills and dated securities) have been issued to sterilise the expansionary effects of forex
inflows. In the context of forex outflows in the recent period, it has been decided to
conduct buy-back of MSS dated securities so as to provide another avenue for injecting
liquidity of a more durable nature into the system. This will be calibrated with the market
borrowing programme of the Government of India. The securities proposed to be bought
back and the timing and modalities of these operations are being notified separately.
The Reserve Bank will continue to closely monitor the developments in the global and
domestic financial markets and will take swift and effective action as appropriate.

Example 1
An investor sells a call option, where the buyer has the right to buy 100 shares in
Universal Widgets S.A. at 90¢. He receives an option premium of 14¢. The value of
the option is 14¢, so this is the premium margin. The exchange has calculated, using
historical prices, that the option value won't go above 17¢ the next day, with 99%
certainty. Therefore, the additional margin requirement is set at 3¢, and the investor
has to post at least 14¢ + 3¢ = 17¢ in his margin account as collateral.
Example 2
Futures contracts on sweet crude oil closed the day at $65. The exchange sets the
additional margin requirement at $2, which the holder of a long position pays as
collateral in his margin account. A day later, the futures close at $66. The exchange
now pays the profit of $1 in the mark-to-market to the holder. The margin account
still holds only the $2.
Example 3
An investor is long 50 shares in Universal Widgets Ltd, trading at 120 pence (£1.20)
each. The broker sets an additional margin requirement of 20 pence per share, so £10
for the total position. The current liquidating margin is currently £60 in favour of the
investor. The minimum margin requirement is now -(!)£60 + £10 = -£50. In other
words, the investor can run a deficit of £50 in his margin account and still fulfil his
margin obligations. This is the same as saying he can borrow up to £50 from the
broker

Sumit

What is CRR?
Indian banks are required to hold a certain proportion of their deposits as cash. In reality
they don’t hold these as cash with themselves, but with Reserve Bank of India (RBI),
which is as good as holding cash. This ratio (what part of the total deposits is to be held
as cash) is stipulated by the RBI and is known as the CRR, the cash reserve ratio. When a
bank’s deposits increase by Rs100, and if the cash reserve ratio is 10, banks will hold
Rs10 with the RBI and lend Rs 90. The higher this ratio, the lower is the amount that
banks can lend out. This makes the CRR an instrument in the hands of a central bank
through which it can control the amount by which banks lend. The RBI’s medium term
policy is to take the CRR rate down to 3 per cent.
What does a hike in this rate mean?
The hike in CRR from 4.5 to 5 per cent will increase the amount that banks have to hold
with RBI. It will therefore reduce the amount that they can lend out. The move is
expected to shift Rs 8,000 crore of lendable resources to RBI. In the past few months the
money that banks have available for giving out as credit is greater than the amount they
have been lending out. This has led to “an overhang of liquidity” in the system. The
objective of the CRR hike is to “mop up” some of the “excess liquidity” in the system

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