Repo rate is the rate at which the central bank of the country or Reserve bank of India(RBI) lends short-term money to commercial banks to meet their business requirements. In this article, we will discuss What is Repo Rate in detail.
In other words, we can also say like it is a monetary tool of RBI which is used to keep inflation under control. It is a key monetary Policy rate interest at which RBI lends money to banks in order to control credit availability, inflation, and economic growth.
At present Repo Rate in India is 4%, which means RBI will lend overnight to any bank at an interest rate of 4%.
How Does Repo Rate Work?
Let us understand this by a general Example. When you borrow money from the bank, the bank charges interest on the principal amount. this is referred to as “cost of credit“
Similarly, banks also borrow money from RBI during a cash crunch on which they are required to pay interest to the central bank or Reserve bank of India. This interest rate is called the Repo Rate.
It is also referred to as “Repurchase agreement” in which bank provides their securities such as treasury bills to get the cash from the central bank and in return central bank get security.
Repo Rate Transaction
Lets us understand the transaction through an example-
- Bank X took a loan of INR 100 Crore from RBI for 1 day by putting the government/corporate bonds as security with an agreement that they will buy back these securities after 1 day. After one day, Bank A returns (INR 100 Crore + interest amount) to RBI and get back their securities.
- This is a repo transaction from Bank A. Transactions of securities may be in government securities or corporate securities or any other securities that RBI allows for transactions.
- The period between the two transactions is called the ‘repo period’. Mainly, repos are performed on an overnight basis, that is, for a period of one day.
How does the Repo Rate affect the economy?
During liquidity/inflation time, central banks increase the repo rate because it acts as a brake for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in controlling inflation.
Thus, the Higher the Repo rate higher will be the cost of borrowing for the bank and vice versa. we will discuss a few scenarios below regarding this.
During a high level of inflation, RBI takes strong action to bring down the flow of money in the market. RBI can do this by increasing the Repo rate. This makes borrowing money a costly affair for banks and thus companies also have to pay more interest if they are looking to expand their business.
As a result, it will slow down the investment and money supply in the market.it negatively impacts economic growth and thus it helps in controlling inflation.
To Increase Liquidity
When RBI needs to increase the flow of money or to pump funds into the system, it decreases the Repo rate. As a result, banks find it cheaper to borrow money from RBI. Hence businesses and investments also see its good time to expand and invest in their business by borrowing money from banks.
This leads to boost growth in the economy and simultaneously maintaining liquidity in the market.
What is Reverse Repo Rate?
Like the customers deposit their surplus funds in the bank to earn interest on it, similarly, banks deposit their surplus to RBI. The rate at which RBI provides interest to banks called the Reverse repo rate.
In simple terms, It is a rate at which RBI borrows money from the banks instead of lending. When there is excess liquidity in the market RBI borrows money from the banks.
An increase in the Reverse Repo rate reduces the cash flow in the financial market and a decrease rate increases the cash flow/liquidity in the market.
A high reverse repo rate could prompt banks to park their funds to RBI in order to earn more interest on them also when RBI reduces the repo rate bank invest their money in distributing loans thus increasing the cash flow in the market.
Significance of Repo Rate
- Repo helps banks to maintain their CRR and SLR ratio on a daily basis. A bank that needs cash to maintain a CRR goes into a repo transaction and receives cash in place of securities and a bank that requires government securities to maintain SLR is the reverse repo transaction to acquire securities and parts with cash.
- The repo rate is a liquidity management tool managed by RBI as it acts the benchmark rates for the economy. When RBI wants to increase the interest rates in the market and decrease the liquidity, it increases the repo / reverse repo rates and vice versa.
Impact of Current Repo Rate
RBI keeps changing the rate over time-based on the financial situation in the country. Modification in rates impacts all the sectors of the economy.
The change in the repo rate can have a direct impact on a big amount of loans like home loans. The objective of reduction in repo rates is to increase growth in the country and improve economic growth. Consumers will thus take more loans from banks, thereby controlling inflation.
A decrease in the repo rate may cause banks to reduce their lending rate. This can prove beneficial for those taking retail loans. As per RBI guidelines, banks / financial institutions have to transfer the benefit of interest rate reduction to consumers as soon as possible.
1-Currently What is the Repo rate in India?
Currently it is 4% in India.
2-What are the stages of a repo transaction?
- Banks offer qualified securities (RBI-accredited securities).
- RBI gives 1 day or overnight loan to the bank.
- RBI charges interest from the bank.
- The banks repay the loan after one day and repurchase the security given to them as collateral.
3-What is the difference between repo and reverse repo rate?
|Repo Rate||Reverse Repo rate|
|Repo rate is the rate at which RBI lends money to Banks||Reverse repo rate is the rate at which RBI borrows money from banks|
|It is used to control inflation and shortage of funds||It is used to manage cash-flow|
4-Who decide the Repo rate?
The RBI governor decides over the meeting of the Monetary policy committee(MPC).
5-What is mean by Collateral?
Collateral refers to an asset that lenders accept as security for a loan.it means if the borrower defaults on the loan the lender can seize the collateral and sell it to cover the losses.
6-What is Monetary Policy?
Monetary policy refers to the policy formulated by the Reserve Bank of India for the purpose of controlling the money supply and the rate of interest in order to boost economic growth.
7-What is CRR and SLR?
CRR or Cash Reserve Ratio is the minimum ratio/percentage of bank deposits as cash. It means the bank has to keep a certain percentage of the total deposits in the current account with the RBI, However, banks do not have that amount for any economic activity or commercial activity.
The SLR or Statutory Liquidity Ratio is the minimum percentage of deposits that a bank has to maintain in the form of gold, cash, or other RBI approved securities.
8-How does Repo rate affect me?
A reduction in the rate means the banks can borrow more money from RBI at a cheaper rate, meaning lending rates for consumers will also decrease.
On the other hand, if interest rates rise, consumers will have less money to spend, which will slow the economy and reduce inflation.
9-What is corporate bonds?
It is a type of debt security issued by a firm and it is sold to investors. The company gets the capital in return and investors get the interest. It’s a good choice for a fixed but higher income on the safe side.