As announced by the central bank of the country, i.e. the Reserve Bank of India (RBI) on 08 October 2021, the current Repo Rate (RR) is 4%. Interest rates on loans are expected to remain steady as the Monetary Policy Committee (MPC) kept the RR unchanged.
Repo Rate (RR) is the rate at which the central bank of the country, i.e. the Reserve Bank of India (RBI), lends money to commercial banks or financial institutions in lieu of securities to maintain liquidity during shortage of funds or because of some statutory measures. It is one of the key tools of RBI to keep inflation under control. Any changes in Repo Rate impact the flow of money in the market. The current Repo Rate is 4% p.a.
Repo Rate meaning or full form is ‘Repurchasing Option’ Rate. It is also called the ‘Repurchasing Agreement’. People borrow loans from banks in times of financial requirement and pay interest on the borrowed amount. Similarly, commercial banks and other financial institutions also go through shortage of funds sometimes. At that time, they can also borrow funds from the country’s apex bank, which is RBI in India. The Central Bank of any country lends money to commercial banks and other financial institutions at an interest rate, known as RBI Repo Rate, on the principal amount.
Repo Rate is one of the main Monetary Policies of RBI. The Governor of RBI presides over the bi-monthly meetings of MPC or the Monetary Policy Committee, which usually consists of 6 members. They formulate, administer and modify the policy rates together. The RBI changes the rates as per the liquidity crunch or surplus in the nation.
There are some components of Repo Rate transaction between banks and the RBI as below:
As mentioned above, even a few basis points (BSP) change in Repo Rate can have a huge impact. Repo Rate influences credit availability, inflation, liquidity, and the economic activities in the nation. When the financial system goes through even the slightest of change, the economy can flourish or suffer. Likewise, the country’s economy must be pushed down sometimes to stabilize inflation.
Below are the impacts of hike or reduction in Repo Rate:
Impact on inflation and economy: When the Repo Rate is high, banks are hesitant to borrow from RBI to avoid paying high interest rates. At that time, banks take precautions not to overspend their cash reserve by minimising their loan grants. This halts the money flow and the economic activities. However, it also prevents inflation. When RBI slashes the rate, it enables the banks to borrow, spend and invest more. Increased cash flow will result in faster business cycles and a boom in the economy.
Impact on bank loan rates: When the RR is high, banks are bound to clear off their loans to the RBI with a higher interest amount. As a result, the banks may charge a higher rate of interest on loans to borrowers to compensate for the same. Fundamentally, RBI discourages borrowing by banks and banks discourage the customers. This process drains out surplus liquidity from the market, resulting in controlling the inflation rate. As the RR declines, banks may also reduce their interest rates to attract more customers. Also, loan applications for customers of commercial banks may become easier. It increases the demand for home loans and other loans. While the customers find financial aid at a lower interest rate, the banks profit through it. This leads to the economical bloom due to a rushed money flow because the cost of funds goes down.
Impact on bank deposit rates: Apart from the interest rates on loans, banks also adjust the interest rate on fixed deposits or savings accounts as per the Repo Rate. RR is a crucial benchmark according to which the banks set up all kinds of rates.
Banks borrow loans from RBI by pledging their securities and then repurchase them the following day. For banks undergoing a cash crunch, the loan is an overnight fund. Although the loan at Repo Rate is usually for 1 day, banks may require it for more than a day. The one-day loan is called Overnight Repo while above that is a Term Repo. Term Repo is also known as a Variable Rate Term Repo. RBI generally announces auction for Term Repo as it can be fixed for 7, 14, or 28 days. When the inflation is higher than the RBI’s standards, it hikes the current Repo Rate of RBI to check it. RBI raises the RR to infuse liquidity in the economy with a lower cost of funds for borrowers.
Bank Rate and Repo Rate, both are powerful tools for RBI to keep a check on money flow and economic activities in the market. However, the main difference between the two is marked by the pledge of government securities to RBI for a loan.
Here are the main differences between the two:
During a high inflation, RBI makes strong efforts to bring down the money flow in the economy and one way to do this is by hiking the repo rate. This increase in RR makes borrowing a costly affair for businesses and industries, and slows down investment and money supply in the market.
Reverse Repo Rate (RRR) is a mechanism of absorbing the liquidity in the market and restricting the borrowing power of investors. RRR the rate at which the RBI borrows funds from commercial banks when required. This happens when there is excess liquidity in the market. The banks then benefit out of it by getting interest for their holdings with RBI. The reverse repo rate today is 3.35%.
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A change in RR affects the liquidity or cash flow in the economy. An increase in RR reduces the flow of money and a reduction in RR increases the flow of money in the economy.
During cash crunch situations, banks and other financial institutions borrow funds from RBI against the eligible securities provided by them to the apex bank. The interest rate on which the RBI lends this money to them is called Repo Rate (RR). RR is an agreement between banks and RBI in which the RBI lends loans to the financial entities against security.
During inflation, RBI makes efforts to bring down the money flow in the economy and one way to do so is by increasing the Repo Rate (RR). Higher RR means higher cost of borrowing for banks and vice-versa.
Repo Rate is decided bi-monthly by the RBI's Monetary Policy Committee. The Repo Rate today is 4%. It has been 4% to date since last year.
When RR is increased, banks are bound to pay higher interest rates to the RBI which in turn prompts them to increase the interest rates on the loan products offered to customers. The customers are then dissuaded from taking credit from banks, leading to a shortage of funds in the economy and less liquidity. Higher repo rate means common people will have to pay higher interest rates on loans.
MCLR is Marginal Cost of Funds Based Lending Rate. It is the minimal interest rate that lenders can charge in case a loan is taken by a borrower. Repo Rate is the rate at which banks borrow money from RBI. The MCLR depends on changes in the RR made by the RBI.
Following are the components of repo transactions between the RBI and the bank:
Higher Repo Rate means higher interest rates on loans and vice versa.
Yes, an increase or decrease in repo rate increases or decreases the home loan interest rates respectively.
Yes, a change in repo rate affects the existing personal loan interest rates.
Banks borrow money from RBI and lend it to their customers at a higher rate of interest, thus, making profits. That is the reason Bank Rate is usually higher than the Repo Rate as it is an important tool to control liquidity.
The current repo rate and reverse repo rate is 4% and 3.35% respectively.