Key differences between Repo Rate vs Bank Rate

Though Repo Rate and Bank Rate have few similarities like both is fixed by the central bank and
used to monitor and control the cash flow in the market, they have some prominent differences
too.

Take a look at the differences between Repo Rate and Bank Rate below.

Bank Rate is charged against loans offered by the central bank to commercial banks, whereas, Repo
Rate is charged for repurchasing the securities sold by the commercial banks to the central bank.
No collateral is involved while charging Bank Rate but securities, bonds, agreements and collateral
is involved when Repo Rate is charged.

Repo Rate is always lower than the Bank Rate.

Increase in Bank Rate directly affects the lending rates offered to the customer, restricting people
to avail loans and damages the overall economic growth, whereas Increase in Repo Rate is usually
handled by the banks and doesn't affect customers directly.
Comparatively, Bank Rate caters to long term financial requirements of commercial banks
whereas Repo Rate focuses on short term financial needs.
Though Bank Rate and Repo Rate have its own differences, both are used by RBI to control liquidity
and inflation in the market. In a nutshell, the central bank uses these two powerful tools to
introduce and monitor the liquidity rate, inflation rate and money supply in the market.

1. What is Repo Rate?

When we experience a financial shortfall, we approach the bank for loans. Likewise, when banks
fall short of funds, they approach the central bank for financial assistance. Repo Rate is the rate at
which the country's central bank, which is RBI in India, lends money to commercial banks during
financial crisis. In other words, commercial banks borrow money from the Reserve Bank of India by
selling securities or bonds with an agreement to repurchase the securities on a certain date at a
predetermined price.

The rate of interest charged by the central bank on the cash borrowed by commercial banks is
called the "Repo Rate". For example: If the Repo Rate is 10% and the loan amount borrowed by a
commercial bank from RBI is Rs 10,000, then the interest paid to the RBI will be Rs 1,000.

On the contrary, when a commercial bank has excess funds, they can deposit the same in the
central bank and earn "Reverse Repo Rate" interest. For example: If the Repo Rate is 10% and the
funds deposited by the commercial bank to the RBI account is Rs 10,000, then, the interest paid to
the commercial bank by RBI is Rs 1,000.

Repo Rate also decides the liquidity rate in the banking system. If RBI wants to increase the
liquidity rate, they will reduce the Repo Rate and encourage the banks to sell their securities and if
the central bank wants to control liquidity, they will increase the interest rate, discouraging banks
to borrow easily. An increased Repo Rate means that the central bank will earn a higher interest
rate from the commercial banks, while an increased Reverse Repo Rate means that the commercial
banks earn high interest from the central bank.

2. What is Bank Rate?

The rate of interest charged by the central bank on the loans they have extended to commercial
banks and other financial institutions is called "Bank Rate". In this case, there is no repurchasing
agreement signed, no securities sold or collateral involved. Banks borrow funds from the central
bank and lends the money to their customers at a higher interest rate, thus, making profits.

Bank Rate is usually higher than Repo Rate as it is an important tool to control liquidity. Also known
as "Discount Rate", Bank Rate is often confused with Overnight Rate. While the bank rate refers to
the interest rate charged by the central bank on loans granted to commercial banks, overnight rate
is the interest charged when banks borrow funds among themselves. When Bank Rate is increased
by RBI, bank's borrowing costs increases which in return, reduces the supply of money in the
market.

Any reduction in the repo rate and bank rate will allow borrowers to avail loans at lower interest
rates but an increase in repo rates will have a corresponding increase in the interest rates of loans.

FAQs on Bank Rate and Repo Rate

1. What distinguishes a bank rate from an interest rate?

The rate of interest is not a tool of credit management since it is not set by the central bank, but
the bank rate is a quantitative tool used in the economy to control the state of inflation and
deflation.

2. What effects do the bank rate and repo rate have on the economy?
The two monetary policy instruments that central banks utilise to affect economic circumstances
are the bank rate and the repo rate. Central banks can influence borrowing, spending, and
investment by changing these rates. Reducing borrowing costs through lowering bank or repo rates
can boost economic activity, while raising rates can reduce inflationary pressures and rein in
excessive lending.

3. Do bank rates and repo rates have the same values everywhere?
No, these rates may have different names and terminology in other nations. The language and
frameworks used by various central banks to control interest rates and liquidity in the banking
sector may differ. To comprehend the comparable rates in a certain nation, it is crucial to consult
the central bank's policy.
4. Is a higher repo rate considered to be good?
Monetary authorities use the repo rate to manage inflation. Central banks raise the repo rate in an
inflationary environment to discourage banks from borrowing from them. In the end, this lowers
the amount of money in the economy, which aids in halting inflation.

5. The reverse repo rate is high; why?

With all else being equal, a rise in the reverse repo rate will result in a drop in the money supply
and vice versa. The amount of money on the market will decrease due to commercial banks having
greater incentives to park their funds with the RBI due to an increase in the reverse repo rate.

6. Why reverse repo rates is always less than repo rate?

Reverse Repo Rate is lower than Repo Rate because: RBI will not offer higher interest on deposits
than loans. RBI earns more through lending than borrowing. It is the spread between deposits and
loans through which RBI earns.