Just like people who seek loans from banks during their financial distress, financial institutions and commercial banks also seek loans from the central bank of their country when they lack funds. In India, the Reserve Bank of India (RBI) is responsible for lending such loans.
Individuals have the option of securing loans with or without collateral. Similarly, banks too have the option of taking loans with or without pledging collateral and securities. This is where the difference between bank rate and repo rate lies.
Bank rate vs repo rate is one of the most asked questions related to banking. The RBI (Reserve Bank of India) is responsible for monitoring both repo rate and bank rate which come under the ROI (Rates of Interest). RBI grants loans to financial institutions or commercial banks based on ROI. The major difference between bank rate vs repo rate is the terms and conditions against which the RBI lends money to banks.
Banks receive loans from RBI under repo rate with collateral which could be agreements, bonds, securities, etc. On the other hand, bank rates have no security. RBI uses these two tools for different purposes and that speaks to their benefits.
What is The Bank Rate?
The bank rate is the discount or rate at which RBI grants advances of loans to commercial banks. Hence, bank rates are also known as the discount rate. The commercial banks who take a loan from RBI have to repay the money with an interest amount on those loans.
Features of Bank Rate
A loan at bank rate is the agreement between commercial banks and the RBI. here are its salient features:
- Collateral: Loans at a bank rate do not require any collateral which means there is no selling and repurchase of securities.
- Tenure: Loans at bank rates mainly focus on financial goals in the long run. It could be an overnight loan, a fortnight loan, or even last for 28 days.
- ROI: Bank rates directly influence the ROI of commercial bank loans as they eventually charge their customers when bank rates increase. This compensates for the higher interest rate they have to pay the RBI.
- Controlled economy: The bank rate causes a change in economic activity as it is a liquidity tool to maintain a regulated economy. The RBI decides the bank rate according to the monetary policy of the country as a change in bank rate changes the ROIs of banks too.
Impact of Bank Rate
The bank loan rates will fall or rise depending on the dip or hike of the bank rate. Fast economic growth can lead to inflation. However, slow economic growth will negatively impact the development of the country. This is the reason why the bank rate is one of the primary tools of the RBI to keep inflation in check.
If the bank rate changes, it will ensure the following consequences:
- High bank rate: A higher bank rate will contract the flow of money and increase the costs of funds for borrowers or commercial banks. It will dampen the growth of the economy and stop when a risk of inflation arises.
- Low bank rate: A lower bank rate will increase the chances of liquidity in the market which will encourage bank loans at a lower ROI. the economy will expand when spending, as well as investments, speed up as now loans will come cheaper.
Policymakers use the bank rate as a weapon to structure the monetary policy of the country. For instance, they will lower the bank rate to pump funds during unemployment and poor economic growth.
What is the Repo Rate?
The banks get loans from the RBI at a repo rate when they offer some securities for the loan taken. Banks can sell off these securities with an agreement to repurchase them. This security can be brought back when the banks pay their interests to the RBI. Repo stands for repurchase option.
Features of Repo Rate on The Economy
Repo rate acts as an anchor to stabilise the economy. Here are some basic characteristics of repo rate:
- Securities: Bank loans can be taken instead of securities. The interest paid for such loans is called repo rates. Securities can be sold and bought for such bank loans. The banks pay charges and buy these securities.
- Tenure: Repo rate has a short tenure of 1 day. RBI can provide overnight loans at a repo rate, therefore, catering to the short-term financial crisis of commercial banks.
- Economic impact: RBI is responsible for the change of repo rate in the monetary policy committee. Any change in the repo rate will alter the economic stability of the country.
Impact of Repo Rate on The Economy
Change in repo rate will either propel or drain excess liquidity in the market. RBI has consistently cut down the repo rate from August, 2018 to August, 2021, that’s 3 years right there. They did so due to the ingoing pandemic and receding economy. Changes in repo lead to these impacts:
- Higher repo rate: A higher repo rate means economic growth shrinks. The borrowing and spending will get costlier for commercial banks and investments will become expensive. Under such circumstances, the growth of the economy will slow down and restrain inflation.
- Lower repo rate: RBI can lower the repo rate to make it easy for bans to borrow money using securities that they can repurchase at a lower rate. A lower repo rate will boost business and industrial ventures and stimulate economic growth.
Repo rates do not affect the bank directly, unlike bank rates. However, change in repo rates may affect the MCLR (Marginal Cost-based Lending Rates) which will in turn affect the rate of home loans.
Bank Rate vs Repo Rate: Difference Between Bank Rate and Repo Rate
In the bank rate vs repo rate debate, we can point out that both affect the inflation and curtail or enhance the credit availability in the market. Here are some notable difference between bank rate and repo rate:
|Point of Comparison||Bank Rate||Repo Rate|
|Type of loan rate||An interest amount is paid by the banks when they take a loan from RBI at bank rate.||Securities are bought back from the RBI when banks take a loan from them at repo rate.|
|Collateral||The loans taken by banks at bank rate are unsecured.||Securities or collateral are sold to the RBI for taking bank pans at repo rate such as bind papers or government securities.|
|Tenure||The time frame of a loan taken at bank rate has a period of 28 days.||Loans taken at repo rate have a time frame of 1 day.|
|Interest rate||Bank rate is higher than repo rate by BPS (Basic Points) as it has no collateral.||Repo rate is lower than bank rate as collaterals are involved in it.|
|Objective||Loans taken at bank rate suffice the long-term requirements and lending rates of banks.||Repo rate is the monetary mechanism that decides the rate of liquidity.|
Bank Rate vs Repo Rate: Similarities Between Bank Rate and Repo Rate
|Point of similarity||Bank Rate vs Repo Rate|
|Interest rate||RBI determines both the rates by considering the country’s monetary policy.|
|Loans taken from||Loans at both these rates are taken from the RBI by commercial banks or financial institutions.|
|Regulations||Both these rates control the economy by regulating the inflation rate and money flow.|
What is the Recent Bank Rate and Repo Rate?
Here are some recent developments in the bank rate vs repo rate sector:
- On 7th February 2019, the repo rate was reduced from 6.50% to 6.25%.
- On 4th April 2019, it was reduced by 25 BPS to 6.00%.
- On 6th June 2019, it was reduced by 25 BPS to 5.75%.
- On 7th August 2019, the repo rate was reduced by 35 BPS to 5.40%.
- On 4th October 2019, the repo rate was reduced to 5.15%.
- On 4th May 2022, the repo rate increased by 40 BPS to 4.40%.
On 22nd May 2022, the repo rate was reduced to 4.00%.
The Bottom Line: Bank Rate vs Repo Rate
When there is an imminent shortage of funds, financial institutions or commercial banks resort to borrowing funds from the RBI. In the comparison of bank rate vs repo rate, the repo rate is preferable to the bank rate as the latter is considered more of a notional concept. On the other hand, if a bank prefers a short-term secured loan, then repo rate loans are the best choice.
Both can, however, accelerate the economy when RBI slashes either the repo rate or the bank rate. But they can also negatively impact the cash flow if they increase. Increasing inflation can also be controlled by changing these rates. RBI exercises both these tools to keep a check on the economic activities of the country by regulating increasing prices.
Bank Rate vs Repo Rate FAQs
1. What is the RBI bank rate?
2. What is the repo rate on a home loan?
3. What is MCLR?
4. Should you change from MCLR to repo rate?
5. Which is better, MCLR or RLLR?
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