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liquidity and to fulfil business requirements. RBI repo rate is the most important policy interest rate
in India. The repo rate is decided by the Monetary Policy Committee headed by the RBI Governor.
The repo rate is used by the central bank of India that is the RBI to signal its monetary policy stance
to the banks, businesses, government and people at large. RBI reviews the repo rate from time to
time as part of the monetary policy review. Generally monetary policy fulfills two objectives –
Keeping inflation under control and accelerating economic growth.
In its second bi-monthly monetary policy for the financial year 2021-22, RBI has kept the repo rate
unchanged to 4.00%. This has been done to limit the damage to the economy caused by the second
wave of Covid-19. Repo rate is the rate at which the central bank infuses liquidity in the banking
system. The reverse repo rate also stands unchanged at 3.35%.
When the central bank wants to signal lower interest rates in the market.
When RBI is reasonably confident that inflation and fiscal deficit are in control and a demand-led
price surge is unlikely.
When the economy is slowing down and the RBI wants to accelerate growth by signalling an
accommodative monetary policy.
When the external balance of payments situation of the country is seen to be stable by the banks.
The cut in the repo rate helps the general public to get the credit at a lower cost and thus it increases
the cash outflow. For example, the cost of the repo rate linked home loan will decrease after the
repo rate cut.
Further, the repo rate cut also helps the industries to get the business loan and mortgage loan at the
reduced rates which eventually pave the way for economic development.
When the central bank wants to signal higher interest rates in the market.
When RBI sees overheating in the economy and perceives a risk that inflation may surge.
When there may be a risk of asset bubbles being created due to excessive capital formation.
When the RBI wants to reduce speculation in foreign exchange or sees a risk of a disorderly
depreciation of Indian currency.
The main differences between the Repo Rate and Bank Rate are mentioned below:
How does repo rate cut translate into lower interest rates?
When the RBI cuts the repo,the cost of funds of banks reduces. As a result, the banks are able to
advance loans to their customers at a lower cost. Banks typically use the repo rate as a signal to
determine their deposit rates, lending rates and base rates.
MyLoanCare expects interest rates in India to increase by 25-75 bps during 2021, a reversal from the
steep reduction in rates that has been witnessed in 2020. Even though the Monetary Policy
announced on 04th Jun 2021 has kept the repo rates unchanged, the upward movement of interest
rates should start to get visible over the next few months, due to multiple reasons.
Greater demand for credit from businesses with a V-shaped sharp economic recovery in the country,
post COVID-19 crisis last year
Gradual tapering of additional liquidity support by central banks globally in wake of Covid-19
pandemic and lockdown.The RBI has now brought the CRR to 4% as on 04th Jun 2021.
Rising fiscal deficit means higher government borrowing and no reduction in small savings rates
Release of Pent-up demand for credit from individuals as people restart spending on consumer
durables and property that was put on hold last year
Budget 2020-21 has announced several large investments in infrastructure sectors, which could
mean a huge demand for credit and hence, higher interest rates
Expected increase in inflation with high spending that should invariably push the interest rates up.
What does it mean for borrowers?
A rate increase of 25-75 bps is likely to result in an increase in EMI’s on home loans by ₹ 15 to ₹ 50
per lakh of the loan amount. The same holds true for all other categories of loan borrowers, be it a
personal loan, auto loan, business loan or property loan. We believe that it is the right time for
borrowers to take or book a loan at the current rates as rates are at an all-time low and may only
move up from here within the next few months.
Banks and NBFCs have so far been in a situation where they had surplus funds due to a high inflow
of deposits and lower loan offtake. However, this might change soon as credit demand is picking up
and CRR has been reset back to 4% from 3% earlier. Soon, Banks and NBFCs may start competing
for deposits and this is likely to push up interest rates on retail deposits by 50-100 bps over the
course of 2021.
Another important tool of Monetary policy is the reverse repo rate, that helps in controlling inflation.
Reverse repo rate is the rate at which RBI provides interest to Banks for depositing funds. It is , thus,
the rate at which the RBI borrows money from the banks, instead of lending money to them.
An increase in the reverse repo rate reduces the cash flow in the financial market, and a cut in the
reverse repo rate increase the cash flow in the market.
A high reverse repo rate could help banks earn more interest, and thus will prompt them to keep as
much money with the RBI as possible.
When RBI reduces the reverse repo rate, banks tend to invest their money in other sources like
lending loans in the market. This way, the cash flow increases.
FAQs
RBI buys government securities from commercial banks at a discounted price. The rate at which it is
discounted is the repo rate. After the agreed tenure, the respective commercial banks repurchase
those government securities from RBI. In simple words, repo rate is the rate at which RBI lends funds
to the banks, based on which banks lends funds to the general public. An increase in repo rate
increases loan rates and vice versa.
The components of a repo transaction between RBI and commercial banks are:
The change of repo rate is aimed to affect the flow of money in the economy. An increase in the repo
rate decreases the flow of money in the economy, while a decrease in repo rate increases the flow of
money in the economy.
The current repo rate in India is 4.00%, effective from 04th Jun 2021.
✅What is the difference between the repo rate and reverse repo rate?
Repo rate is the rate at which banks borrow money from RBI. Whereas, the reverse repo rate is the
rate of interest at which RBI borrows money from commercial banks.
Bank rate is the rate at which RBI offers loans and advances to domestic banks. Repo rate is the rate
charged by RBI for repurchasing the government securities sold by domestic banks.Cash Reserve
Ratio (CRR) is the ratio of cash mandated by RBI to be maintained by commercial banks against its
total deposits.Statutory Liquidity Ratio (SLR) is the reserve required to be maintained by commercial
banks in the form of liquid cash, gold reserves, and RBI approved securities before approving any
credit to the customer.
✅What is the difference between MCLR and Repo Rate?
Repo Rate is the interest rate at which the commercial banks borrow money from the RBI by using
government bonds as collateral to achieve their fiscal goals. MCLR rate is a base Rate below which a
bank can not lend money to anyone. It replaced the base rate system to determine the lending rates
for commercial banks.
Inflation refers to the situation where the power of money decrease and the prices of goods
increase. This mainly happens because people have more money and goods are limited. To control
inflation in the economy RBI uses the monetary tool: Repo rate. If RBI increases the repo rate, then
the people will be tempted to deposit the money with the banks and will be discouraged to take
loans. Thus, it will reduce the money in the hands of people and eventually control inflation.
Repo rate is the monetary tool to control the supply of money. An increase in repo rate will increase
the cost of the loan, thereby loans linked to repo rate will be available at higher rates, and at a
comparatively bigger EMI. When the repo rate decreases, loans become affordable. The Reserve
Bank of India tries to fix the repo rate according to the prevailing conditions in the economy.