Bank Rate Vs Repo Rate – Everything You Must Know
In the banking sector, a central bank controls all the commercial or domestic banks throughout the country. Apart from laying down specific financial laws and guidelines, a central bank also decides the introductory rate of interest at which other banks can borrow loans in case of financial losses or cash crunch. In India, the central bank is the RBI (Reserve Bank of India). According to the Banking Regulation Act, 1949, RBI has the power to inspect and supervise the operations of any commercial banks in the country. RBI also sets the bank rate and the repo rate for other banking institutions to borrow loans. Even though most people usually assume bank and repo rates to be the same, there are some noticeable differences that we must be aware of. To know more about bank rate vs repo rate, keep on reading.
What is The Bank Rate?
In cases of cash crunch, commercial banks often take a loan from the central bank to keep the operations running. According to the country’s monetary policy, the central bank can then lend short-term loans to these banks at a particular rate of interest. This rate of interest is known as the bank rate.
The bank rate ultimately affects how an ordinary citizen can borrow money from the said commercial banks. Therefore, policymakers set the bank rate so that the balance in the economy is maintained. Thus, when the policymakers decide to reduce the bank rate, it helps stimulate the economy as the interest rate for common citizens also reduces. In such a case, more people borrow money from banks, and there is a noticeable increase in expenditures all over the nation.
When the bank rate is reduced, commercial banks lower their interest rates for ordinary people. It means more investment and expenditure all over the nation.
Similarly, when there are chances of inflation due to a rapid spike in the economy, the bank rate increases. Thus, as loans get more costly, the money supply is automatically lessened, and expenditure is visible.
Therefore, we can say that the bank rate is an impactful factor that helps guide our economy in a certain way. The central bank alters bank rates to control the supply and demand of a currency in the nation. For example, when there is a notable increase in unemployment, the bank rate is reduced to facilitate more people getting loans at a cheaper rate.
What is the Repo Rate?
Commercial banks can take loans from the central bank against some collateral like securities or bonds to maintain liquidity in the market. In such situations, the bank promises to buy back its security from the central bank. The rate at which commercial banks buy back their security at any decided rate is known as the Repo rate. Repo rates affect liquidity, inflation and currency supply in the country.
RBI, along with the Monetary Policy Committee, decides the bank rate and repo rate, thus affecting the growth of the nation’s economy.
When there’s high inflation in the market, the central bank tries to reduce the money supply. To do that, the repo rate is increased. It makes things challenging for banks and other business organizations to borrow money. Thus, there is less investment in the market, and ultimately the economy slows down. Even though this leads to a negative impact on the economy, the inflation rate is also reduced.
When the repo rate is reduced, currency supply in the market increases. As a result, businesses find it easy to borrow money. Since the cash flow increases, there’s a noticeable boost in the economy.
Bank Rate Vs Repo Rate: What is the Difference?
Bank Rate Vs Repo Rate Latest Update: The Reserve Bank of India (RBI) dropped the repo rate by 75 basis points on March 27, 2020. (bps). The repo rate was reduced from 5.15% to 4.40% as a result of the decrease. The bank rate is currently 4.65%. Borrowers will be able to acquire loans at lower interest rates if the bank rate and the repo rate are both reduced.
Definition: When there is a cash crunch in the market, the bank rate is applied on the loan that the central bank offers to commercial banks. At the same time, the repo rate is charged for commercial banks purchasing back their securities from the central bank.
Collateral: One of the major bank rate and repo rate differences is that the bank rate never involves any form of collateral, while the repo rate always involves collateral like securities, bonds or agreements.
Value: Bank rates are always higher than repo rates.
Deals With: The bank rate directly affects the country’s customers because it alters how an average citizen can borrow money from the banks. But the repo rate affects banks and other business organizations.
Purpose Bank Rate vs Repo Rate: Bank rates focus on dealing with commercial banks’ long-term financial requirements, while repo rates help deal with short-term financial goals.
What is the Difference Between Repo Rate and Bank Rate Usual Timeline: The time limit for loans taken under bank rates lasts longer than 28 days. But in the case of repo rates, loans are usually overnight and dealt with within one day.
Repurchasing Effects Due to the Difference Between Repo and Bank Rate: Based on the general definition, we can conclude that no repurchase agreements are involved with bank rates. However, the concept of repo rates itself is based on a repurchase agreement.
Bank Rate Repo Rate Difference as a Deciding Factor: Bank rates help determine the lending rates for loans in our country. Whereas repo rates help maintain a balance in the liquidity in our nation.
What is the Reverse Repo Rate?
For maintaining the currency supply in the nation, the central bank borrows money from other banking institutions. Thus, other commercial banks can avail benefits and earn interest as profit while their money is safely stored with the central bank. The reverse repo rate is the interest that RBI pays to other commercial banks for borrowing their funds.
When the cash flow in the market increases, the reverse repo rate is also increased. It motivates other banks to store their money with RBI, thus ultimately reducing the chances of more loans to citizens or business organizations. This helps reduce the currency flow and maintain a balance in the economy.
The reverse repo rate is the rate at which RBI borrows money from commercial banks.
The common difference between the reverse repo rate and repo rate is repurchasing agreement. While the repo rate is decided for the repurchase of collateral, there is no such agreement in the case of the reverse repo rate. Also, the reverse repo rate is usually lesser than the repo rate.
In every country, an apex banking institution has power over other commercialand domestic banking institutions. This central bank is responsible for keeping a balance in the economy and maintaining liquidity. But when there’s a visible cash crunch or sudden increase or decrease in inflation, the central bank changes the bank rate and repo rate accordingly. RBI (Reserve Bank of India) sets a fixed rate for lending loans to commercial banks in India, known as the bank rate. But when the loan is given on securities, the commercial banks promise to purchase their collateral at a predetermined time. The rate at which the collateral is purchased back from the RBI is termed the repo rate. The bank rate directly affects the customers’ ability to borrow loans from the banks, while the repo rate affects the business organizations or banking institutions in case of liquidity. No matter how similar both these terms sound, there’s a visible difference in the case of bank rate vs repo rate.
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