In order to mitigate the risk of economic recession, RBI on the 27th of March’20 announced some relief measures for easing the financial crisis looming over the country. In our today’s article, we will try to decode these announcements in a layman language. We will be as elaborative as we can for our readers. So here we go…
On 27th March, in response to the ongoing demand from various industries and trade associations, India’s central bank; Reserve bank of India announced few measures to provide relief to the already stressed financial condition of the country.
Before we deep dive into what it means for us, let us first understand a few concepts here. The main objective of RBI is to control Inflation and ensure the growth of our economy, particularly GDP. To do this, RBI controls the supply of money in the economy i.e. how much money should be available for the industry or the economy as well as the cost of it. To implement this, they have come up with certain monetary policies, which comes as a handy tool for the entire banking system. Let us see one by one, how it makes use of the same.
Disclaimer: This may get a little technical for a naïve in finance. If you are someone who is just looking for the only the impact of the RBIs announcement can skip this part.
Cash Reserve Ratio (CRR): It is the ratio of the entire deposits a bank has through its Savings account and Fixed deposits. Currently, CRR is 3% (reduced by 100 bps from 4%) which means Banks have to keep this portion in cash with the RBI which will not fetch any interest or profits. Hence, the bank cannot lend this amount to anyone.
Statutory Liability Ratio (SLR): It is that portion of the total deposits that the bank collects through fixed deposits and savings bank deposits, which banks are required to invest in interest-bearing instruments in the form of liquid assets such as gold, treasury bills or RBI approved securities such as government securities. Current SLR is 18.5%
Repo Rate: When we need money, we take loans from banks. And banks charge a certain interest rate on these loans. This is called a cost of credit (the rate at which we borrow the money). Similarly, when banks need money they approach RBI. The rate at which banks borrow money from the RBI by selling their surplus government securities to RBI is known as “Repo Rate.” Repo rate is the short form of Repurchase Rate. Generally, these loans are for short durations up to 2 weeks. Currently, it is 4.4 % (down from 5.15%)
Reverse Repo Rate: Reverse repo rate is the rate of interest offered by RBI when banks deposit their surplus funds with the RBI. When banks have surplus funds but have no lending (or) investment options, they deposit such funds with RBI. Banks earn interest on such funds. Currently, it is 4%
For someone who skipped the above section can now start reading from here J
Using these tools, RBI EITHER infuse more money in the market when they see a slump in the economy (by reducing CRR and SLR, banks has more money at hand to lend) to boost consumption and therefore GDP OR suck the excess liquidity (by increasing CRR and SLR, banks has limited funds to lend) to contain the demand if too much demand is causing inflation.
However, during the current Covid-19 crises, the scenario is a bit different. There is absolutely no production of goods or services in the entire country. Businesses are striving hard to meet their obligations be it Rent, Salary, EMIs, and other fixed costs. Without sales, there is absolutely zero realization. Hence there is no generation of income, especially for business owners. Therefore, RBI stepped in and permitted banks, financial institutions to allow a moratorium of 3 months for all EMIs or interest falling due between 1st March to 31st May’20.
Now let us understand the fine prints and underlying meaning of this moratorium scheme announced by RBI:
Firstly, RBI has permitted all institution whether it is Commercial banks (Including NBFCs, Rural co-op banks, Small finance banks, Housing Finance Institutions, or Microfinance Institutions) to allow or grant payment holiday for 3 months in respect of their Term loan or Home loan obligation falling due between 1st March to 31st May’20. This is also applicable to their working capital facility where interest payment is also deferred for 3 months straight.
What it means: By now, it is already clear that this is not a waiver but deferment. This is a relaxation from the central bank in this trying times to have an option to repay not now but later. The interest will continue to accrue and it will be added back to the principle on a monthly basis. So a borrower has the following 3 options to repay.
To repay back all at once in June in Bullet payment
Keep EMI the same, but extend the tenor
Keep the tenor same, but increase EMI
If you are a business owner and still not clear about what to do, whether or not to opt for Moratorium, please sign up and our expert will guide you for a FREE session worth Rs. 2500/- (for 1st-time users only).