Repo rate is the interest rate at which the central bank of a country, like the Reserve Bank of India, lends money to commercial banks in case of a financial shortfall. Basically, it is the interest rate at which banks borrow from the RBI. This is quite similar to banks charging interest from borrowers on home loans or any other loan. Repo rates set the tone for all interest rates in the banking sector, thereby influencing the economy, making it an important tool for controlling inflation.
Meaning of Repo Rate
Repo rate stands for ‘Repurchasing Option’ rates, also known as ‘Repurchase Agreement’. During a cash crunch, banks and financial institutions seek extra funds from the RBI in the form of loans at a particular interest rate. This much-needed capital is availed at the prevailing repo rate against collateral such as gold, treasury bills or bonds. Later, banks repurchase these securities upon repayment of the loan.
How Does the Repo Rate Work?
The Monetary Policy Council (MPC) alters the repo rate periodically to regulate the nation’s economy. Repo rate affects liquidity in the market by raising or curtailing the flow of money. It is a crucial benchmark for the economy. A high repo rate restricts economic activity as this leads to banks borrowing less from the RBI. But when there is a fall in the repo rates, the borrowing trend spikes with increased liquidity. As a result, these changes also influence the lending policies of banks; impacting their rate of interest on home loans, bank deposits and retail loans.
Current Repo Rate in India
Since May 2020, the repo rate remained unchanged at 4%. However, this year has seen a revision in these rates. As per the MPC update of 5th August 2022, the current repo rate stands at 5.40%, which is a rise of 50 basis points. In May 2022, RBI had hiked this rate by 40 basis points, followed by another increase in June.
The recent trend of repo rate changes are tabulated below:
|Month of Update
|05th August 2022
|08th June 2022
|04th May 2022
|09th October 2020
|06th August 2020
|22nd May 2020
|27th March 2020
|06th February 2020
|05th December 2019
|10th October 2019
|07th August 2019
|06th June 2019
|04th April 2019
|07th February 2019
How Does the Repo Rate Affect Our Economy?
Repo rate is a powerful instrument that can modulate the nation’s cash supply, inflation levels and liquidity. It directly influences the cost of borrowing for banks and affects the economy in the ways mentioned below:
RBI curbs high inflation levels by raising the repo rate and reducing the flow of money into the economy. Consequently, all forms of credit borrowing become costlier for businesses and industries, slowing down cash supply and investments in the market. Thus, the economic growth is adversely affected, albeit temporarily; which brings the inflation within requisite limits.
Raising Market Liquidity
When the RBI wishes to release more funds in the market, it lowers the repo rate. This results in easier availability of credit for various investment purposes at cheaper interest rates. Such a scenario boosts the economy by increasing cash flow into the system.
Components of Repo Rate Transaction
Repo transactions between the RBI and banks are conducted depending on the following essential factors:
- Collateral security – This includes the collateral that banks offer the RBI such as government bonds, treasury bills, gold and other RBI-approved securities; which should be above the Statutory Liquidity Ratio (SLR) limit.
- Inflation levels – Repo rates are lowered or raised according to the inflation level to keep a check on the country’s economy.
- Hedging and leveraging – RBI hedges and leverages by buying securities and bonds from banks, providing them with cash against the deposited collateral.
- Short-term funds – These loans are given for short duration, which is usually overnight or as per agreed terms. After this period, banks purchase back their deposited securities at a pre-determined price.
- Cash reserve ratio (CRR) – Banks borrow money from the RBI to maintain liquidity or the mandatory cash reserve ratio.
Understanding Reverse Repo Rate
Reverse repo rate is a repurchasing agreement pledged by the RBI. It is an effective tool that absorbs market liquidity and restricts borrowing. Whenever there is excess liquidity in the market, RBI borrows money from banks at a specific rate referred to as the reverse repo rate.
During times of high inflation, RBI raises the reverse repo encouraging banks to deposit more money with them, and earn higher interest on their surplus capital. Although, this leaves banks with lesser funds for consumer loans and other forms of credit; they consider this a safer alternative backed by government securities along with improved earnings.
On the other hand, a lower reverse repo rate acts as a deterrent for banks to make deposits with the RBI. In such cases, they prefer lending to customers and gain higher profits.
Key Differences Between Repo Rate and Reverse Repo Rate
Some of the striking differences between repo rate and reverse repo rate are:
|Reverse Repo Rate
|This is the rate at which RBI lends to banks
|This is the rate at which RBI borrows from banks, both public and private
|Lending rate is higher than the borrowing rate i.e. reverse repo rate
|Repo rate determines the reverse repo rate. The spread between the two represents the RBI’s income; hence, reverse repo is always less than the repo rate
|It is an instrument for controlling and managing inflation levels
|It helps to regulate lending and cash flows
|This involves pledging securities, which are repurchased at a later date
|Here a transfer of funds takes place, from one account to another, just like any other loan
Repo rates have a direct impact on home loans. When borrowers link their home loan interest rates to the RBI repo rate, they tie their interest rate to an external benchmark providing some transparency. Bajaj Housing Finance offers attractive repo rate-linked home loans. With simple eligibility criteria, prospective borrowers can easily avail of low interest rates and flexible loan tenors. They can also use the online home loan EMI calculator to assess and customise home loans as per convenience.
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