Bank Rate vs Repo Rate is one of the most commonly asked questions. The Reserve Bank of India (RBI) monitors both the Bank Rate and the Repo Rate. Also, both of which are rates of interest (ROI) on which RBI grants loans to commercial banks/financial institutions. But the terms and conditions against which RBI lends the money mark the difference between bank rate and repo rate. RBI lends money at a repo rate when banks offer collateral. It could be securities, bonds, agreements, etc. There is no security in loans at the bank rate. The purpose for which RBI uses these two tools determines the benefits of both.
Bank Rate and Repo Rate – Definition, Features & Impact
Just like people who seek bank loans in times of cash crunch, banks also approach the Central Bank of the country. Commercial banks and financial institutions also go through a shortage of funds. They can borrow loans from the Central Bank of the country. In India, the Reserve Bank of India – RBI is the apex bank. Individuals have options of secured and unsecured loans. In a very similar fashion, RBI can grant loans both with and without pledging securities and collateral. Herein, lies the difference between bank rate and repo rate. Let us first understand the meaning and features of bank rate and repo rate.
What is the Bank Rate?
Bank Rate is the rate or discount at which RBI grants loans or advances to commercial banks. Hence, it is also called Discount Rate. The money that commercial banks repay to RBI is the interest amount on the loans.
The loan at bank rate is an agreement between the RBI and the commercial Banks. Below are its salient features:
- They do not require any kind of collateral, which means that there is also no selling and repurchase of eligible securities
- Loans at the bank rate focus on the long-term financial goals of commercial banks. It can be an overnight loan, fortnight, or even 28 days
- Bank rate directly affects the rates of interest (ROI) of commercial bank loans. Commercial banks eventually charge their customers when there is an increase in the bank rate. It is to compensate for the higher interests they pay to RBI
- The bank rate is also meant for a long-term rate change and economic impact. RBI decides the bank rate as per the Monetary Policy of the country. It is a liquidity adjustment tool of RBI to keep the economy in control. It is because the bank rate can change the rates of interest of banks
Reiterating the fact that bank loan rates rise or fall according to the hike or dip in the bank rate. Rapid economic growth has a risk of inflation. On the other hand, slow economic activities negatively influence the nation’s development. It is one of the primary tools of RBI to keep inflation in check. The change in bank rate has the following effects:
- If the bank rate is high, then it contracts the money flow. It is because it increases the costs of funds for commercial banks’ borrowers. It dampens the economic growth but is done when there is a fear of quick growth and consecutive inflation
- If the bank rate is low, it enhances the liquidity in the market and encourages borrowing as bank loans, which also come at a lower ROI. Spending and investments speed up when loans are cheaper and the economy expands
Policymakers use the bank rate as a latent weapon to structure the monetary policy of the nation. For instance, they will lower the bank rate to pump funds when there is unemployment and the economy is down.
What is Repo Rate?
Repo Rate is the loan rate at which RBI grants loans to banks when the latter provides some securities. Banks sell off these securities with an agreement to repurchase them. It is bought back when the banks pay the interest at the rate of ‘REPO’. REPO refers to ‘Repurchase Option’.
RBI imposes the Repo Rate for banks that act as an anchor for economic stability. Some basic characteristics of repo rate are:
- There is selling and buying of securities. It is thereby called ‘Repurchase Agreement’. So, the banks pay the charge for these securities to buy them back
- Repo rate has a short tenure of one day
- Like the bank rate, RBI also presides over meetings of the Monetary Policy Committee to decide the repo rate. It is the apex body that has the authority to alter the repo rate for consequential economic changes
- RBI provides overnight loans at repo rate. Therefore, it caters to the short-term financial needs of commercial banks
RBI changes repo rate either to drain excess liquidity from the market or to propel it. RBI has been consistently cutting down the repo rate from 2018 August to August 2021 due to the receding economy and the pandemic has also taken a toll. Changes in repo rate have such impact as discussed below:
- When the repo rate is high, the economic activities shrink. The borrowing and spending get costlier for commercial banks. In turn, the investments become expensive and the economy slows down. It is a step to restrain inflation
- RBI will lower the repo rate so that it has a positive impact on the economic activities in the country. Banks can easily borrow money pledging securities as they can repurchase at low rates. It also boosts industrial and business ventures which stimulates the economy
Unlike bank rates, the repo rate does not directly affect the bank rates. However, it may affect the Marginal Cost-based Lending Rates (MCLR), which, in turn, can modify the rates of home loans.
Difference Between Bank Rate and Repo Rate
RBI monitors both bank rate and repo rate. Both are to enhance or curtail credit availability in the market and inflation. However, there are notable differences between bank rate and repo rate based on key elements as below:
1. Type of Loan Rate
Both are rates at which RBI lends loans. Banks pay the interest on loans and the principal amount for loans at bank rate. Banks pay to buy back the securities from RBI for loans at the repo rate
The repo rate has collaterals like government securities or bond papers while loans at the bank rate are unsecured ones. This is one of the major and basic dissimilarities between the two
Loans at repo rate have a time frame of 1 day whereas the loans at bank rate have the period of up to 28 days
4. Interest Rate
The bank rate is always higher than the repo rate by a BPS (Basis Points). ‘Basis Point’ is one-hundredth of a percentage point or one percent of a percent. Equivalently, it is one ten-thousandth
1/100 of % = 1% x % = 1/10,000
The bank rate comes with no collateral as well as for a longer time duration. Hence, it is higher
Bank Rate loans suffice long-term lending rates and requirements of banks. Whereas, the repo rate is a monetary mechanism to decide the liquidity rate
Similarities and Differences between the Bank Rate and Repo Rate
|Bank Rate vs Repo Rate||Repo Rate||Bank Rate|
|Similarities between Bank Rate and Repo Rate||RBI determines the rate||RBI determines the rate|
|Banks take loans from RBI||Banks take loans from RBI|
|Controls money flow and inflation rate, Regulates economy||Controls money flow and inflation rate, Regulates economy|
|Dissimilarities between Bank Rate & Repo Rate||Banks pay to repurchase the securities||Banks repay the loan with the interest amount|
|Overnight funds with 1-day tenure||Tenure can be up to 28 days|
|Short-term needs of the commercial banks. It impacts the liquidity rate in the banking system||Long-term needs of the commercial banks. It affects the lending rates in the country|
|Does not directly affect the interest rates of the banks||Directly affects the interest rates of bank loans|
|Lower than the Bank Rate with a few BPS||Higher than the Repo Rate|
*Repo Rate is also a part of LAF – Liquidity Adjustment Facility. It is a policy where banks can borrow through repurchase agreements.
Wrapping it up:
Banks resort to borrowing only when there is an imminent shortage of funds. When compared, Repo Rate is more preferable to the Bank Rate. Bank Rate is considered to be a more notional concept. On the other hand, the repo rate loans are preferable as it is a short-term and secured loan. However, both accelerate the economy when RBI slashes either the bank rate or the repo rate. Both the bank rate and repo rate negatively impact the cash flow when RBI increases their rates. But they also arrest inflation when its trajectory is rising. Therefore, the RBI exercise both these tools to keep the economic activities going in a balanced way. It, thus, keeps a check on the rising prices and declining purchasing power of the people within limits.