Page 19 - Insurance Times May 2019

average inflation is less than lower tolerance (2%) for three Y Repo rate
successive quarters.
Y Reverse Repo rate

So the risk is if average inflation is more than 6% for three Y Cash Reserve Ratio (CRR)
successive quarters or less that 2% for three successive Y Statutory Liquidity Ratio (SLR)
quarters.Similarly, on GDP front, the risk is actual GDP is
Y Other
lower than planned.
Repo Rate
So from monetary policy point of view, we have identified
the risk. The next step is to measure the risk in quantitative A rate at which RBI lend money to commercial banks in the
terms. event of shortfall of funds. Whenever banks have any
shortage of funds they can borrow from the RBI. A reduction
Risk Measurement in the repo rate helps banks get money at a cheaper rate
and vice versa.
The time to failure is three successive quarters, so this is
our time line for measurement of risk. The projected What happens when repo rate increases?Banks lend from
inflation is calculated using the current inflation, projected RBI at a higher rates of interest which in turn lead to
prices, weather conditions and econometric models. The borrowing at a high rate of interest. Higher borrowing rate
inflation is also simulated at 50%, 70% and 90% statistical reduces borrowing activity which reduces money supply
confidence level to identify the range of future inflation for leading to lower inflation and lower GDP
the defined period.

What happens when repo rate decreases? Banks lend from
Apart from this, sensitivity testing are also performed on RBI at a lower rates of interest which in turn lead to
crude oil price by 10% for both up and down shock to borrowing at a lower rate of interest. Lower borrowing rate
identify resulting level of GDP and inflation. Such sensitivity increases borrowing activity which increases money supply
helps in understanding the future outlook and be prepared leading to higher inflation and higher GDP
now, if the actual scenario turns out to be like in sensitivity.

Reverse Repo rate
The measurement of the future outlook helps in taking the
risk mitigation plan now. Reverse Repo rate is the rate at which the RBI borrows
money from commercial banks. Banks are always happy to

Risk Management lend money to the RBI since their money is in safe hands
with a good interest.
Risk management is a third step in the risk management
cycle. There are four tools under the risk management, they An increase in reverse repo rate can prompt banks to park
are
more funds with the RBI to earn higher returns on idle cash.
Y Accept the risk It is also a tool which can be used by the RBI to drain excess
Y Avoid the risk money out of the banking system.
Y Transfer the risk
Reverse Repo rate effect on inflation
Y Manage the risk
If RBI increases this Reverse Repo rate, it means RBI wants
Being in the economy, the risks can hardly be avoided, so to contraction of credit. When RBI gets loan from banks at
this option cannot be applied. Also, the government does high rate of interest, more and more banks will supply to
not have option to transfer the risk, for such purpose, RBI central bank because it is safe and earning is more. Effect
have been established. Inflation and GDP are output of of this will on financial market. Supply of money in financial
various economic activity, so there are no option except to market will decrease. Due to decrease in the supply of credit
accept the risk and manage it. So management of risk is the in the market, inflation rate will decrease.
only option that can be taken out.
Cash Reserve Ratio (CRR)
How RBI manages the risk of inflation out of the band and GDP The Cash Reserve Ratio refers to a certain percentage of
below target. RBI uses following tools to manage the risks. total deposits the commercial banks are required to

The Insurance Times, May 2019 19