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Difference Between Bank Rate and Repo Rate
These days, most home loan borrowers choose to link their loan interest rates to an external benchmark. This helps maintain transparency and compels lenders to transfer the benefit of a rate cut to the borrowers. If you are repaying a loan and you are on floating interest rates, you must familiarize yourself with the concepts of Bank Rate and Repo Rate as both of these rates have a direct impact on an individual’s EMIs and total interest payout. If you are already not familiar with these terms, read on.
What is Repo Rate?
The term Repo is the short form for Repurchasing Option. Very often, lenders within the country find themselves short on funds. In other words, sometimes, lenders find that they do not have enough money to lend. When this happens, domestic banks and financial institutions can borrow money from the central bank of the country, i.e., the Reserve Bank of India, by pledging government-recognized securities, such as bonds, treasury bills, cash, gold, etc. When a financial institution borrows money from the central bank of the country at the Repo Rate, the agreement is that the bank will pledge certain securities, which it will repurchase before the agreed period. It is for this reason that when lenders within the country borrow money from the central bank by pledging government-approved securities, the interest rate that the central bank charges is known as the Repo Rate.
Since we are discussing Repo Rate, we must also understand the concept of Reverse Repo Rate. When lenders borrow money from the central government by pledging securities, the interest rate that the central bank charges financial institutions within the country is known as the Repo Rate. On the other hand, when lenders within a country have surplus funds, they deposit those with the Reserve Bank of India and earn interest on it. The rate of interest at which the Reserve Bank of India borrows money from commercial lenders within the country is known as the Reverse Repo Rate. The current Repo Rate is 6.50% and the current Reverse Repo Rate is 3.35%.
What is Bank Rate?
Lenders within a country lend money to borrowers and earn interest. Sometimes, commercial lenders borrow money from the central bank of the country and then lend this money to the borrowers. When lenders within the country borrow money from the Reserve Bank of India without pledging any security, the rate of interest at which the Reserve Bank of India lends money to the lenders is known as the Bank Rate or the Discount Rate. Since in this case, there are no securities involved, the Reserve Bank of India charges a higher rate of interest than the Repo Rate. Thus, the Bank Rate tends to be higher than the Repo Rate. However, as of today, the Bank Rate is lower than the Repo Rate.
The Reserve Bank of India uses both the Repo Rate and the Bank Rate as monetary policy tools. The government uses these tools to curb inflation and maintain smooth economic growth. When inflation within the country goes up, the RBI increases the Repo Rate and the Bank Rate. Thus, lenders borrow money at a higher rate of interest from commercial lenders and therefore, they also charge a higher rate of interest from the common man. Thus, when the RBI increases the Repo Rate and the Bank Rate, loans become expensive. Therefore, borrowers borrow less money, which in turn, reduces the flow of money within the economy. This helps curb inflation. If, on the other hand, the flow of money within the economy reduces and the RBI wants to promote the flow of money within the economy, it decreases the Repo Rate and Bank Rate.
Key Difference Between Repo Rate vs Bank Rate
Let us now walk you through the differences between the Bank Rate vs Repo Rate.
- The primary difference between Bank Rate and the Repo Rate is that Bank Rate is the interest rate that the Reserve Bank of India charges commercial banks, lenders and financial institutions on simple loans. The Repo Rate is the interest rate at which the Reserve Bank of India lends money to commercial banks and lenders within the country when they borrow against securities and commit to repurchasing these securities at a future date.
- The Bank Rate is almost always higher than the Repo Rate for when the central bank of the country lends money without any security or collateral, the risk for them is higher. Thus, they charge a higher rate of interest in this case. Also, while we are on this topic, the Reverse Repo Rate is always lower than the Repo Rate.
- Any increase in the Bank Rate has a direct effect on customers since every time the RBI increases the Bank Rate, banks too increase the interest rates they charge on loans. Thus, when the Bank Rate goes up, loans become expensive. On the other hand, when the Bank Rate goes down, loans become cheaper. The Repo Rate also affects how borrowers borrow money but the effect of a repo rate hike is slow to pass to loan borrowers.
- Lastly, the Reserve Bank of India normally uses Bank Rates to ensure long-term economic growth within the country. On the other hand, it uses Repo Rate to take care of short-term financial needs.
Both Bank Rate and Repo Rate are important monetary policy tools that the Reserve Bank of India uses to maintain economic growth within the country. Since any changes in these rates directly affect borrowers, borrowers must have a good understanding of how these tools work, how any changes in them affect the common man and what are the key differences between these various rates. Hope this article has been able to provide you with some clarity on these aspects.
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