The recent repo rate cut by RBI was announced on 7 August 2019, along with the reduction in the bank rate. The bank rate has been adjusted to 5.65% p.a. against the new repo rate of 5.40%. The lowering of both repo rate and bank rate indicates good times for borrowers, as commercial banks getting a lower rate, both with and without security converts to ordinary borrowers getting cheaper loans.
Differences between Repo Rate and Bank Rate
Repo Rate and Bank Rate are the two most popular rates calculated for borrowing and lending activities carried on by commercial and central banks. They are the lending rates at which the Central Bank of India lends funds to commercial banks and other financial institutions. While both rates are short term tools used to control the cash flow in the market and are often mistaken to be one and the same, there is some noteworthy difference between the two.
Before we make a comparison about the repo rate and the bank rate, it is important to first understand what both these terms mean. Simply put, repo rate is the rate at which the RBI lends to commercial banks by purchasing securities while bank rate is the lending rate at which commercial banks can borrow from the RBI without providing any security. Both the terms have been explained in a descriptive manner in the subsequent sections, along with their comparisons.
Key differences between Repo Rate vs Bank Rate
Though Repo Rate and Bank Rate have few similarities like both is fixed by the central bank and used to monitor and control the cash flow in the market, they have some prominent differences too. Take a look at the differences between Repo Rate and Bank Rate below.
- Bank Rate is charged against loans offered by the central bank to commercial banks, whereas, Repo Rate is charged for repurchasing the securities sold by the commercial banks to the central bank.
- No collateral is involved while charging Bank Rate but securities, bonds, agreements and collateral is involved when Repo Rate is charged.
- Repo Rate is always lower than the Bank Rate.
- Increase in Bank Rate directly affects the lending rates offered to the customer, restricting people to avail loans and damages the overall economic growth, whereas Increase in Repo Rate is usually handled by the banks and doesn’t affect customers directly.
- Comparatively, Bank Rate caters to long term financial requirements of commercial banks whereas Repo Rate focuses on short term financial needs.
Though Bank Rate and Repo Rate have its own differences, both are used by RBI to control liquidity and inflation in the market. In a nutshell, the central bank uses these two powerful tools to introduce and monitor the liquidity rate, inflation rate and money supply in the market.
What is Repo Rate?
When we experience a financial shortfall, we approach the bank for loans. Likewise, when banks fall short of funds, they approach the central bank for financial assistance. Repo Rate is the rate at which the country’s central bank, which is RBI in India, lends money to commercial banks during financial crisis. In other words, commercial banks borrow money from the Reserve Bank of India by selling securities or bonds with an agreement to repurchase the securities on a certain date at a predetermined price. The rate of interest charged by the central bank on the cash borrowed by commercial banks is called the “Repo Rate”. For example: If the Repo Rate is 10% and the loan amount borrowed by a commercial bank from RBI is Rs 10,000, then the interest paid to the RBI will be Rs 1,000.
On the contrary, when a commercial bank has excess funds, they can deposit the same in the central bank and earn “Reverse Repo Rate” interest. For example: If the Repo Rate is 10% and the funds deposited by the commercial bank to the RBI account is Rs 10,000, then, the interest paid to the commercial bank by RBI is Rs 1,000.
Repo Rate also decides the liquidity rate in the banking system. If RBI wants to increase the liquidity rate, they will reduce the Repo Rate and encourage the banks to sell their securities and if the central bank wants to control liquidity, they will increase the interest rate, discouraging banks to borrow easily. An increased Repo Rate means that the central bank will earn a higher interest rate from the commercial banks, while an increased Reverse Repo Rate means that the commercial banks earn high interest from the central bank.
What is Bank Rate?
The rate of interest charged by the central bank on the loans they have extended to commercial banks and other financial institutions is called “Bank Rate”. In this case, there is no repurchasing agreement signed, no securities sold or collateral involved. Banks borrow funds from the central bank and lends the money to their customers at a higher interest rate, thus, making profits. Bank Rate is usually higher than Repo Rate as it is an important tool to control liquidity. Also known as “Discount Rate”, Bank Rate is often confused with Overnight Rate. While the bank rate refers to the interest rate charged by the central bank on loans granted to commercial banks, overnight rate is the interest charged when banks borrow funds among themselves. When Bank Rate is increased by RBI, bank’s borrowing costs increases which in return, reduces the supply of money in the market.
What is recent in Repo Rate and Bank Rate?
The Reserve Bank of India (RBI) on 7 August 2019 slashed the repo rate by 35 basis points (bps) after which the repo rate stands at 5.40%. The bank rate has also been cut down which takes the current figure to 5.65%. Previously, the central bank had reduced the repo rate in the monetary policy review that happened in June 2019, by 25 bps.
The reduction in the repo and the bank rate could mean a reduction in the EMIs (equated monthly instalments) for borrowers if the rate cuts are passed on by the banks. Borrowers are likely to enjoy lower interest rates if banks reduce their lending rates which they can do only after evaluating their operating costs, cost of deposits, etc.