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CMA Intermediate · Financial Management and Business Data Analytics · Financial Institutions

The RBI lowers the repo rate, the rate at which it lends short-term funds to commercial banks against government securities. Other things equal, what is the most likely immediate effect on banks?

A lower repo rate reduces the cost at which banks borrow short-term funds from the RBI, so banks can lower their lending rates and credit becomes cheaper. It does not automatically change CRR or SLR, which are set separately by the RBI.

  1. ABanks' cost of borrowing from the RBI falls, which tends to lower lending ratesCorrect
  2. BBanks' cost of borrowing from the RBI rises, which tends to raise lending rates
  3. CBanks must raise their CRR balances by the same percentage
  4. DBanks' SLR requirement is automatically abolished

Explanation

Repo is the rate banks pay to borrow from the RBI. A lower repo rate reduces banks' cost of funds, so they can reduce lending rates and credit becomes cheaper. A rise in the repo rate would have the opposite effect. Repo changes do not automatically alter CRR or SLR, which are set separately.

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