In the current monetary system, the Reserve Bank of India uses the repo rate as a money market tool to achieve several fiscal goals for the economy. Below is a detailed insight into this concept and related aspects.
The term ‘REPO’ denotes repurchase option or agreement. Used as a tool in the money market, it facilitates borrowings through collateral of specified debt instruments in the economy, which can include government bonds, treasury bills and the likes. When lending finances, the central bank charges interest at a specified rate called repo rate.
In context of the Indian money market, the Reserve Bank of India (RBI) lends money to commercial financial institutions at this rate, which is subject to changes as per the running policies. All commercial lenders in India can approach RBI as their lender of the last resort during fund shortage and borrow money for a definite tenor against the deposit of government bonds as collateral.
As borrowers, these financial institutions pay interest to the RBI as per the applicable repo rate. At the tenor’s end, they can repurchase these bonds from RBI by repaying a predetermined price.
The rate can change from time to time. In India, the decision regarding current repo rate is taken at the Monetary Policy Council (MPC) meeting headed by the RBI Governor. As a monetary tool, it primarily serves to keep inflation in check apart from fulfilling other monetary requirements.
The final lending rate for various products offered by BHFL will be arrived at after taking into account market reputation, repo rate, interest, credit and default risk in the related business segment, historical performance of similar homogeneous clients, profile of the borrower, tenure of relationship with the borrower, repayment track record of the borrower in case of existing customer, subventions available, deviations permitted, future potential, group strength, overall customer yield, nature and value of primary and collateral security, etc.
The importance of repo rate extends to its effects on various aspects of a country’s economy.
a) The RBI uses it as a control mechanism to infuse or decrease liquidity in the financial system.
b) A change in repo rate affects the cost of funds for commercial banks, thus impacting their policies regarding retail lending.
c) Cuts in repo rates can be immensely useful in controlling inflation and achieving price stability in the financial market.
d) Change in repo rates affects other rates like home loan interest rate, rates on bank deposits, etc.
As per these policies, repo rate is primarily used to control and regulate the available liquidity in India’s economic system. An increase in these rates limits the availability of liquidity, thus curbing a surge in inflation as well as bringing it down.
Alternatively, any reduction in this rate enables increased borrowings for commercial lenders as a result of reduced cost of credit. The recent Monetary Policy regarding cuts in repo rates has been in line to increase liquidity in the financial system, thus driving economic growth.
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