6 Major Differences Between Bank Rate and Repo Rate

Bank rates and repo rates are both short-term tools for regulating the flow of money in the market. Their functions are similar in limiting inflation and liquidity and aiding in balance inquiry. We must discuss bank rate vs repo rate in detail to know about both concepts in a better way. Let us get a handle on their meaning before diving into the contrast.

The Reserve Bank of India keeps an eye on the repo and bank rates.

Defining Repo Rate

In times of economic distress, the Reserve Bank of India (RBI) loans money to commercial banks at an interest rate known as the repo rate.

The repo rate controls the rate at which banks can borrow funds. If the Reserve Bank of India (RBI) needs to boost the liquidity rate, it can do so by lowering the repo rate and urging the banks to unload their securities.

Both policymakers and central banks use interest rates to influence the economy. A repo rate is a monetary policy tool the central bank uses to manage the amount of money in circulation, inflation, and market liquidity. When the Central Bank has to pump funds into the economy, it lowers the repo rate, making investment borrowing easier. It boosts economic growth by raising the money supply.

Defining Bank Rate

The bank rate, also called the discount factor, is the interest rate the central bank charges commercial banks when they borrow money. Bank rates influence the rate of central banks’ borrowed money.

When interest rates are lowered, the economy benefits. As a result, the cost of borrowing money drops, which can encourage borrowers to take out more loans, increasing overall spending. If policymakers believe inflation will rise, they will likely hike the bank rate. It is used to decide economic and monetary policy.

The RBI raised the repo rate by 50 basis points, from 4.40% to 4.90%, on June 8, 2022. The current interest rate at the bank is 5.15%, a 50 basis point (bp) increase from the prior rate of 4.65%.

Repo Rate vs Bank Rate—Key Differences

The repo rate and bank rate are both set by the central bank and used to keep tabs on direct market liquidity. But there are important distinctions between the two, which we have discussed in detail below.

1. The interest rate the central bank charges for investing the money back from financial institutions is the repo rate, and the interest rate the central bank charges for lending money to these banks is the bank rate.
2. In contrast to charging the bank rate, charging the repo rate involves using assets, leases, agreements, and collateral.
3. Compared to the bank rate, the repo rate is relatively fixed and sure to be constantly lower.
4. Since fewer people will take out loans at the higher bank rate, the economy will feel the effects. In contrast, the repo rate is handled by banks and has no direct effect on clients.
5. The bank rate serves the long-term funding needs of commercial banks, but the repo rate meets their more immediate liquidity needs.

Let us examine these six major comparative points regarding bank rates vs repo rates in brief:

1. Added loan fee: The bank rate is the interest rate that a central bank charges for a loan that it makes to a commercial bank; in contrast, the repo rate is the interest rate that a commercial bank charges to purchase securities that a commercial bank has previously sold to a central bank.

2. Aim: Long-term objectives can be met with bank rates, whereas intermediate objectives can be met with repo rates.

3. Repurchase Agreement: Money borrowed from the Central Bank at the bank rate is not subject to any arrangement. The loan is made to the commercial bank at a set interest rate. However, in the case of the repo rate, banks enter into a repurchase arrangement. As part of this deal, the bank has promised to repay the loan at a specific interest rate.

4. Use of Collateral: No collateral is needed while negotiating bank interest rates. With repo rates, on the other hand, the loan is approved only after the collateral is presented.

5. Rate: Almost always, the bank rate is greater than the repo rate.

6. Effect of Rate Changes: When the bank rate is raised or lowered, the economy and consumers are directly affected. For example, if bank rates rise, loans will cost more as the interest rate rises. This restricts credit and impedes economic expansion. Rates that are lowered result in lower interest rates and more affordable loans. As a result, lending and borrowing increase, boosting the economy. The economy is not affected in this way by reverse repo.

Conclusion

We hope the six key differences regarding bank rate vs repo rate are clarified. The country’s Central Bank is the highest authority on monetary policy and is responsible for setting and regulating bank and repo rates. These rates control the money supply, inflation, and bank lending rates. Reducing the repo rate and the bank rate allows borrowers to avail themselves of loans at lower interest rates. An increase in repo rates, therefore, will have a corresponding increase in the interest rates on loans.

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Are you looking for similar finance blogs? Visit the Piramal Finance website and help yourself to the knowledge of wide-ranging financial products and services, especially credit cards and personal loans.