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Bank rate vs repo rate: All you need to know

[ecis2016.org] How is the RBI’s repo rate different from the bank rate? We explain the differences and similarities between the two

Home buyers may often hear about how a repo rate cut by the Reserve Bank of India (RBI) is likely to impact home loan interest rates. They may also hear similar things being mentioned when the banking regulator reduces the bank rate. This may lead them to confuse the two terms – bank rate and repo rate.

You are reading: Bank rate vs repo rate: All you need to know

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Bank rate vs repo rate

The repo rate and bank rate are two different types of interest rates that the RBI charges from scheduled banks in India, to lend funds to them. India’s banking regulator can grant loans to banks, with or without the pledging of securities and collateral. This very fact creates a difference between the bank rate and the repo rate. (Read our guide on RBI monetary policy repo rate)

Bank rate and repo rate are short-term lending rates and are periodically changed by the RBI, to maintain credit flow in the market.

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What is bank rate?

Bank rate is the interest rate that RBI charges, when the borrower bank does not provide any security against the loan. Also known as discount rate, bank rate allows banks to borrow from the RBI without having to provide any collateral or securities. This means they do not have to sign any repurchase agreement with the apex bank. At present, the RBI charges 4.25% bank rate from banks on lending funds.

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What is repo rate?

Repo is the interest rate that the RBI charges from banks, on loans against which they provide a security. Since there is a security involved, the RBI and the borrower bank sign a repurchase agreement. In this repurchase agreement, the bank promises to repurchase the securities or bonds they provide as the collateral on a certain date, at a predetermined price.

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At present, the RBI charges 4.90% repo rate from banks on lending funds.

[ecis2016.org] What is repo rate

 

Bank rate vs repo rate: Main difference

Parameter Bank rate Repo rate
Rate Bank rate is usually higher than repo rate. Repo rate is usually lower than the bank rate.
Security Bank is not liable to provide any security against the loan. Bank is liable to provide a security against the loan
Agreement No requirement to sign a repurchase agreement, as there is no collateral involved. The RBI and the bank have to sign a repurchase agreement.
Objective Bank rate focuses on a bank’s long-term financial goals. This means RBI provides short-term loans at repo rate, to cater to the short-term financial requirements of financial institutions.
Impact In case of high bank rate, liquidity in the system contracts. Lower bank rates are meant to encourage borrowing. A cut in repo rate means borrowers will be offered loans at lower rates. The opposite is also true – a hike in repo rate will increase the cost of borrowing for the borrower.
Other names Bank rate is also known as discount rate. Repo rate refers to repurchase option.
Tenure Bank rate can be offered for overnight loans or fortnights. Repo rate has a short tenure of a day.
Policy tools Decision on bank rate change is taken during the RBI’s bi-monthly monetary policy. Decision on repo rate change is taken during the RBI’s bi-monthly monetary policy.

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Category: Must Knows

Debora Berti

Università degli Studi di Firenze, IT

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