What is Repo Rate?

It is a general question among many individuals. The repo rate is basically the interest rate at which Reserve Bank lends money Banks and Financial Institutions in India against government securities. The RBI lends money to commercial banks. Right now, the Repo Rate for 2022 is 4.40%.

It is very important to know about repo rate and how it works. When the Repo Rate changes, money flow in the market is affected. Whenever the RBI slashes its interest rates, it expands the economy by increasing the amount of money in circulation. However, high-interest rates restrict the growth of the economy. The economy is affected by a wide range of factors today.

In order to understand what is REPO rate, it is important to know that REPO rate is an abbreviation for the Repurchasing Option Rate. It can also be called the ‘Purchasing Agreement’ by some people. In times of financial crunch, people borrow money from banks, paying interest on the amount lent. A shortage of funds is also a challenge for banks and financial institutions in the commercial sector. Almost every nation has many banks that lend money to a commercial bank at a rate based on a percentage of the principal amount borrowed.

The RBI is the government’s official agency for selling eligible securities, including treasury bills, gold, or bond papers. As soon as the banks repay their loans to the RBI, these securities can be repurchased and purchased. This process is known as the ‘Repurchasing Option’. The interest rate is the Bank Rate if they take out the loan without pledging the securities.

Comparing Repo Rates & Bank Rates

There are two essential tools that the Reserve Bank uses to keep a check on economic activities and the flow of money in the market. The only difference between the two is the pledge of government securities to the RBI as a loan condition. Here are some similarities between the two and some significant differences.

Similarities

Inflation and liquidity both have a profound influence on one another. Customers should be able to access the benefits of the interest rate cuts that banks and financial institutions have benefited from. Thus, a decrease in the base rate should be necessary. A bank’s base rate is what it charges its customers, which the RBI sets. Whenever the Base Lending Rate is reduced, loans can be obtained at cheaper rates, and EMIs will be lower.

Dissimilarities

• When a bank or financial institution borrows money from the market without securing the loan with collateral, this is called the Bank Rate. Generally, the rate of interest charged by the RBI when commercial banks borrow money from it is known as the repo rate.
• There is usually a difference between a bank rate and a Repo rate since, with the former, the RBI lends funds without any security.
• When loans are at Bank Rate, they are usually made for a longer-term, while at Repo Rate, they are meant for a shorter period.
• Even though either rate change may affect commercial banks’ customers, changes in the Bank Rate directly affect the interest rate of loans. As a result of the difference in the repo rate, it may take some time for the banks to update the loan interest rates. Essentially, this is due to the shorter duration of the repo rate.

Difference between Repo Rate vs Reverse Repo Rate

Repo rates are rates at which the RBI offers loans to banks and financial institutions based on government securities. The reverse repo rate is a rate of interest that the RBI offers banks that deposit funds with them regularly.

Importance of Repo Rate

The RBI is one of its monetary policies. The Monetary Policy Committee, which meets bi-monthly, is presided over by the RBI Governor. There are usually six members on the committee. They are responsible for formulating, implementing and modifying the RBI’s policy rates.

 

• Banks lend money through a legal agreement with the RBI under which collateral is required.
• Securities and bonds can be used as collateral. The banks can repurchase securities at a predetermined price and specific date. If a bank defaults and fails to pay back the cash on a predetermined date, the RBI has the authority to sell these securities.
• As a result of a lack of adequate cash reserves, banks borrow money to make up for the problem. As a statutory requirement, banks are often required to borrow money to keep a minimum reserve balance.

Conclusion

To control inflation and balance the economy, the RBI uses the Repo Rate as a controlling instrument. A rise in inflationary pressures or a fall in inflationary pressures would result in an opposite stance by the RBI. It also speeds up the economy when the economy is cooling off, and the interest rate is low. Also, it may increase or decrease the frequency of loans and the loan amounts issued by the banks. Repo Rates affect your loan interest rates, and all your loan interest rate is typically linked with Repo Rates.