Difference Between Bank Rate and Repo Rate

It is a well-known fact that the Bank Rate and Repo Rate are linked with the interest rate policy of the Reserve Bank of India. The interest rates, money supply, and inflation are controlled using these two tools by the Reserve Bank of India (RBI).

Bank Rate and Repo Rate are rates used for borrowing and lending by the commercial and central banks. The financial transactions between the central bank and commercial bank are conducted using these rates.

What is a Bank Rate?

The rate at which commercial banks and other financial institutions borrow money from the RBI is the Bank Rate. In the event of a shortage of funds, banks and other financial institutions borrow money from the RBI at bank rate which is otherwise known as the discount rate and use the funds for lending to individuals at a higher rate. There is no collateral involved for this transaction.

Bank rate charged to the banks has a direct impact on the lending rates of the banks. If the bank rate charged is higher then the lending rates of the banks will be higher and if the bank rate is lower then the lending rate will be lower.

Bank Rates are used by central banks of different countries to control the currency supply for the progress of the national economy and their banking sector. When the unemployment is on the rise, the central banks will reduce the bank rates, so that loans are available at a lower rate in the market.

What is a Repo Rate?

The rate at which RBI lends to commercial banks is the Repo Rate. In order to raise money, in the event of a shortage of funds, commercial banks sell short-term securities and bonds recognised by RBI with an agreement to repurchase the security at a future date at a pre-determined rate. The contract entered into between RBI and the commercial bank is the repurchase agreement. The rate charged by RBI for this transaction is the Repo Rate. The repo operations inject liquidity into the banking system.

RBI controls the liquidity in the banking system using Repo Rate. If it wants to increase liquidity it will decrease the Repo Rate and encourages the banks to sell securities and it will increase the Repo Rate if it wants to decrease the liquidity and the banks will reduce their borrowing. The Repo Rates will influence the cost of credit for banks.

What is the Difference Between Bank Rate and Repo Rate?

The following are the difference between Bank Rate and Repo Rate:

  • Banks and other financial institutions borrow money at Bank Rate from the RBI and there is no collateral involved in this transaction. There is no repurchase agreement for this transaction.
  • Government securities recognised by RBI are offered as collateral security for funds borrowed by the commercial banks and other financial institutions at Repo Rate. They enter into a contract by way of repurchase agreement wherein the banks sell the securities to RBI with an agreement to repurchase the same at a future date at a pre-determined rate.
  • Bank Rate is higher than the Repo Rate by 100 bps.
  • Repo Rate caters to short-term requirements of the banks and other financial institutions. Bank Rate caters to long-term requirements of the banks and other financial institutions.
  • The lending rate is not affected by Repo Rate since the banks and financial institutions bear the burden of an increase in Repo Rate.

On the contrary, the Bank Rate has a direct impact on the lending rates. If Bank Rates are increased the lending rates will increase and if the Bank Rates are decreased the lending rate will decrease.

How Do These Rates Impact Inflation?

Inflation can be controlled by controlling the money supply in the economy. RBI controls the liquidity rates applicable to the banks in order to control the money supply.

Some of these rates are Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Bank Rate, Repo Rate and Reverse Repo Rate. These methods devised are called Quantitative methods and are explained below:

  • The percentage of money that the banks have to maintain with the RBI is the CRR. For instance, if CRR is 4% then for every 100, 4 should be deposited with RBI and the bank can retain 96.
  • The percentage of available funds that the banks have to invest in specified government securities is SLR.
  • The rate charged by the RBI for the funds borrowed by the banks is the Bank Rate
  • The rate charged by the RBI for the funds lent to the banks is Repo Rate
  • The rate charged by the banks for the funds borrowed by RBI from the banks is the Reverse Repo Rate.

All the above-mentioned rates except the Reverse Repo Rate have a direct impact on the lending rates of the banks. In the case of Reverse Repo Rate, there is an inverse impact on the lending rates. The availability of funds for the banks increases if the Reverse Repo Rates decrease and there will be a decrease in the availability of funds if the Reverse Repo Rates increase.

RBI controls the liquidity in the banking system using these rates. If it wants to increase liquidity it will decrease these rates. When the unemployment is on the rise, the RBI will reduce the rates, so that loans are available at a lower rate in the market. Lower lending rates will encourage individuals to organise funds for various purposes by borrowing.

Also, when inflation is on the rise, RBI will increase the rates and control the supply of money in the economy.

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