Who controls Loan Rates in India? RBI’s tools for interest rates

Who controls Loan Rates in India? RBI’s tools for interest rates

By Ankita Patil
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Loan Rates

Loan Rates in India

The banks issue loans to us with a significant component known as interest rate. An individual always takes this interest component into consideration, whether it would be investing or taking loans. In India, the Reserve Bank of India determines and controls the loan rates with various parameters such as PLR, CRR, SLR, repo and reverse repo rate.

If you are investor, you will look for higher interest rates. And if you a borrower, you will search for lower interest rates. But you must also be knowledgeable about the authority and the essential parameters controlling these interest rates. We will discuss this in greater detail.

Prime Lending Rate – PLR – An influencing factor

This can be known as the benchmark for setting the interest rates by banks. The lending institutions consider the PLR and then determine the rates of interest on different loan products. Let us study this with a common example. A particular bank may state that their interest rate will be 0.8% higher than the prevailing PLR.

This refers that when the PLR increases, the interest rate on loan also increases and vice versa.

Cash Reserve Ratio – CRR – Higher the CRR, higher the interest rate

There is direct relationship between cash reserve ratio and the interest rate. What is CRR? It refers to the cash deposits set aside by the bank according to the RBI guidelines on daily basis. When CRR increases, the banks lend less to the individuals. This increases the interest rate so that there would be less number of loan applications. CRR is an important tool in the hands of RBI for adjusting the liquidity and maintaining inflationary pressures in the economy.

Repo rate – More lending and lower interest rates

The interest rate at which the money is lent to the banks by RBI is known as repo rate. When banks need to borrow money from RBI, they need to refer to the repo rate.

Let us study the relationship of repo rate and interest rates. When there is decrease in repo rate, it means that the interest rates are lowered. Lower interest rates helps in attracting loan applications from the public. This also works in opposite way when the repo rate increases.

Reverse repo rate – Opposite of repo rate

The reverse repo rate is the rate at which RBI borrows funds from commercial banks. This works well in case the reverse repo rate is higher.

Statutory Liquidity Ratio – SLR – Affects PLR and thereby interest rates

SLR refers to the funds stored by every commercial bank in the form of cash or gold or government securities. With this ratio, the RBI can control the credit expansion capacity of the bank.

This ratio has an impact on the PLR and we already know that increase in PLR increases interest rate and vice versa.

Conclusively, we must be aware that RBI is the controlling authority to decide on the interest rates. In reality, RBI checks inflation in the economy by using its monetary tools such as SLR, CRR, repo rate, reverse repo rate and PLR.

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2 COMMENTS

  1. A really informative piece!
    This article was a complete guide for me,as i used to think who decides as to what should be the interest rate? Through this article i came to know the whole procedure, all the deciding factor PLR,CRR, repo rate etc. which are used to calculate the interest rate and imply it. Really knowledgeable!!

  2. If you ask people about the current loan rates of various banks, they would answer promptly but if you ask questions like who controls loan rates in India, they might not be able to answer. Most of the people gain only the required information and ignore the basics. A great piece of information that helps you know the basics. Thanks Ankita!

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