23 Replies to “On what basis does the RBI increase the lending interest rates?”

  1. So many economic and international factors guide RBI to increase or decrease lending interest rates. These include inflation, economic growth, money supply, forex position, international lending rates, economy’s priorities, macro channelising of funds in a desired manner……etc.

  2. Irrespective of the reasons involved in the hike, it would hurt the end customers like myself or yourself. Our government only knows one thing, and that is how to suck up more money from the general pubic. Increase taxes, increase interest rates, increase penalties or other charges. I thought that india is progressing, but does that mean inflation. Heck, i dont want to even thnk about it anymore.

  3. rbi basicaly works on the inflations and deflations of the indian economic system.its interest rates are also affected by the changing rates of world bank

  4. When money supply in circulation is more, price of same commoditie increases. We say inflation is up. Here sufferers are poor people, as their income does not increase, as that of rich people. Now if Government wants elections to win, it has to contain inflation.So to curb money supply, RBI increases lending rate to Banks. Banks in turn increases lending rate to its customers.


  6. Interest is nothing but cost of money. Like any other commodity cost of money also varies with its supply and demand. When money in circulation or liquidity increases it tends to feed inflation by increasing demand for goods and services. That’s why RBI steps in to keep inflationary pressures under check so as not to affect economic growth but also ensure adequate money supply.

  7. whenever the indian economy faces inflationery situation .. its time to show yellow card – the RBI thinks so and it encourages increase in lending rates. But the indian money market is driven by a parallel market which deals with cash only and its size is enormous and uncontrollable.

    Hence the RBI’s action has no direct bearing in the economy except the fact that its action drives shivers down the share market and manufacturers market etc.,

    The best way to control the inflation is to hold the bull by its horn not by its tail. Crores of money (black included) are changing hands everyday in the real estate market and the exponential price rise is not checkd so far…

    the logic is quite simple my dear watson.. politicians are playing the real estate market too..

  8. To control the flow f funds for storing essential items.
    More over to have check on internal money circulation.

  9. RBI increases rates basically on LIBOR rates that is released in UK. One of the other reasons for rate hike is based on inflation. Inflation which indirectly means too much money spending is curtailed using this tactic.

  10. Simple logic – Demand and Supply – they increase it when the demand by public for money in form of loan is raising.

    When public wants more money from banks in the form of loan, the RBi observes this and increases the interest rate slowly.

    Same way, when the money circulation falls or slows down, or when it wants the money circulation to increase, it simply drops down the interest rate. Naturally that attracts more customers for loans.

  11. The interest rates on Loans are deregulated by the RBI. It means, all the individual banks are free to decide Interest rates on the basis of their Asset and Liabilities Position and Net cost of funds. However, the RBI have some other methods, which are indirect in nature, but have direct impact to increase or decrease lending rates and in turn increase or decrease deposit rates. These are Repo rate(A rate at which RBI repurchases Treasury Bonds), reverse repo rate, Capital adequacy norms, sale-purchase of dollar in the open market (It squeezes Rupee supply or vice versa), norms for priority sector lending, and by way of changes of various natures in the credit policy, like policy change to finance some sector(Recently RBI directed the Banks to go slow in Real Estate Sector and reduce exposure), or broad guidelines for financing new avenues, easier access to foreign funds.

    This is a very vast topic and need thorough learning. But surely it is a very interesting topic to understand how our banking sector works or reacts. If you understand this, you will be able to advise your parents that Rates on Banks Fixed Deposit are likely to increase or decrease and the how likely is the interest rate on your Home loan changing and in which way.

    One small tip: Yesterday RBI has instructed to the banks to match the interest rate on personal loans with the cost of funds. As you know, interest rate on personal loans ranges between 15 % (Mostly Public Sector banks) to 45 % (Private and Foreign banks and NBFC’s like GE Contriwide, Bajaj Finance, Citi finance etc’s). You will agree that there is no relation between deposit rates (9 to 11 %) with this rate. Now you will be able to understand that interest rate are likely to reduce in Personal Loan, more specifically in Private and foreign banks and in NBFC’s. If they wont react, RBI may go to charge them under usurious interest rate act or under other provisions.

  12. The main reason is to control inflation.
    RBIs presumption is, since the rate of interest is increased, the demand for credit will decrease. And buying of many things which are not of immediate requirement will be postponed. In fact, the cost of land and the houses in urban places have shot up to a very high level due to the availability of credit at cheaper rates.

  13. RBI increase the lending interest rates based on the inflation rate. This is to contain money supply. According to the economic theory increased supply of money to the market induce inflationary tendencies and therefore to reduce money supply the lending interest rate is increased so that demand for money is thereby reduced.

  14. The RBI would raise guide banks to raise interest rates if the inflation rate is high due to excessive demand (not if its because of a supply crisis), to reduce consumer spending by borrowing and encourage saving. If the savings level is low and borrowing is too high to sustain or if there is too much money in the hands of the consumer and thus prices are rising, the RBI usually uses the repo rate, CRR as tools to suck in money from the system – which will decrease the availability of funds for the banks to lend out and hence increase the interest rates.

  15. India has one of the highest interest rates in the world. I do not understand why our interest rate shall be related to the world bank and other global parameters. Why it does not be at par with other low interest rate economies?

  16. RBI does not increase interest rates. Bank Boards have been vested with the powers to independently evaluate and prescribe interest rates .
    Each Bank has an “Asset Liability Committee”(ALCO) which is empowered by the Board to monitor structural liquidity and interest rate sensitivity on the residual maturities of assets and liabilities in their balance-sheet, arrive at their “net interest margins”(NIMs).
    ALCOs look at the “repo” rate of the RBI as the benchmark “call money floor rate”. Typically, there is a 3 to 4% difference between average interest rate on deposits and on loans and advances.

    RBI prescribes the repo rate after monitoring inflation, money supply (M3), Trade balances, FDI, stock market indices, LIBOR and US inflation, monsoon forecasts and the “yield curve”.
    RBI reviews its “monetary stance” every quarter and comes up with an annual stance and a mid-term review.

    Therefore, the RBI is a watchdog and the Banks are independently working on their NIMs and their ALCOs prescribe interest rates.

    The only area where RBI prescribes interest rates is on “priority secotor advances” at the micro level in tune with the “poverty alleviation programmes”

  17. Many economist have certain “what to do” when certain Hypothetical situation arise. These are even if followed to the book can not guarenttee the corectness of result as there are no set and provan therom as in mathematics. So even those minds who apply these changes are not sure whether it will bring in right result. Therefor I can say for sure even RBI does not for sure know why they are doing what they are doing.

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