Bank rate and repo rate are short term tools for controlling cash flow in the market. Both rates are used for lending and borrowing money by commercial and central banks. There are many people who consider both of these rates as same, however, there is a difference between repo rate and bank rate.
Read on to find out what are repo rate and bank rate, what are the similarities between them as well as the differences that they bear.
Repo rate or repurchase rate is the interest rate at which commercial banks and financial institutions can borrow funds from central bank (Reserve Bank) whenever they have shortage of funds. Commercial banks borrow funds from central bank by selling securities, usually bonds, with an agreement to repurchase the same at a predetermined rate and date. This facility is for short term measure and to fill gaps between demand and supply of money in a bank. Central bank charges some interest rate on the cash borrowed by banks (This rate is usually less than the interest rate on bonds). This interest rate is called as ‘repo rate’.
When a bank is short of funds, they borrow from bank at repo rate and if bank has a surplus fund then they deposit the funds with central bank and earn at reverse repo rate. The lender of securities is said to be doing repo whereas the lender of cash is said to be doing ‘reverse repo’. If the central bank wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate. Approximately six times a year, a group of people called the Monetary Policy Committee (MPC), meet up to decide if and how the repo rate should be changed.
Bank Rate also referred to as discount rate, is the rate at which commercial banks or financial institutions get short term loan from the central bank. This rate has a direct impact on the rates used by banks to lend money to their customers, which in turn affect investments such as bank deposits, bond issues, mortgages. This term has largely been replaced by newer terms base-rate and prime rate. Changes in the bank rate are often used by central banks to control the Money supply.
Banks make a profit by borrowing at a lower rate and lending the same funds at a higher rate of interest. If the RBI hikes the bank rate, the interest that a bank pays for borrowing money (banks borrow money either from each other or from the RBI) increases. It, in turn, hikes its own lending rates to ensure it continues to make a profit.
Similarities Between Repo Rate & Bank Rate
- Both rates are fixed by Central Bank (RBI)
- Both are short term tools for controlling cash flow in the market
Differences Between Repo Rate & Bank Rate
- While bank rate is charged by central bank (RBI) to the commercial banks against loan issue, the repo rate is charged for repurchasing securities.
- In repo rate, there is a need of securities submission. In bank rate, there is no need of security submission.
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