Difference Between Bank Rate & Repo Rateby Tushar Singh Investment Banker
Reserve Bank of India works in tandem with commercial banks and financial institutes to maintain financial stability in the economy. The Central Bank of India, RBI works on monetary reforms and policies to create balance in the financial market using several measures and instruments. Bank rate and Repo rate are the few of those instruments used by RBI.
Bank rate is the rate at which the Reserve Bank of India lends money to the commercial bank and financial institutes, without having them to sell their securities. On the other hand, the is the rate at which the Reserve Bank of India lends to the commercial bank in exchange for securities. The commercial banks can purchase those securities at a predetermined date with interest. It is basically a repurchase agreement between the RBI and the commercial banks. Changes in the repo rate help to control inflation in the economy.
Key Differences Between Bank Rate and Repo Rate
Even if both the instruments are used to manage the financial stability in the economy, yet they have different key features that separate their mechanism. The following are the major differences between the two instruments used by RBI.
Bank rate is the rate charged against the loan provided to the commercial bank by the central bank of India, RBI. While on the other hand, the Repo rate is the interest rate charged by the apex financial body on the repurchase of the securities sold by the commercial banks.
Types of needs served
Bank rates are used for long term purpose, for more than 90 days, or it can even last up to 1 year whereas, the repo rate is used when the fund is borrowed for short term.
The Interest rate charged
Since the fund borrowed is for the long term so, the rate of interest charged is high. The funds borrowed for short duration under the repo rate is charged at a lower interest rate than the bank rate.
Under the repo rate, the sale of securities is carried out as per the repurchase agreement. The sale of securities is done at a pre-determined date and rate whereas, there is no sell of securities involved under the bank rate. The funds are borrowed by the commercial banks at a fixed rate.
Types of tools
Bank rate acts as a tool to determine the long-term lending rate in the economy. On the other hand, the repo rate acts as a monetary tool, used to decide the liquidity of money in the banking system and manage the inflation rate.
When funds are raised through bank rates, then no collaterals are required to be provided to the RBI. Whereas, under the repo rate, funds are borrowed after collaterals are surfaced to the RBI. Collaterals including securities, agreements, and bonds can also be provided to the apex body.
Change in bank rate directly affect the lending rate to the customers, restricting them on borrowing and hence, damaging the overall economic growth of the country. Whereas, change in repo rate does not directly affect the lending rate, but once change comes under play then the banks are required to change their Marginal Cost of Lending Rate(MCLR) below which they’re not allowed to lend money to the customers.
Bank rate is considered to be a latent tool. Nowadays, banks resort to repo rates for their borrowing purpose from RBI. Under the Repo rate, the repo agreement allows commercial banks to keep government securities as collaterals with RBI. It can be repurchased at a predetermined rate. Though both of the tools hold differences, yet the government may use them to control inflation, liquidity of money in financial institutes and to check the overall growth in the economy.
Created on Jan 2nd 2020 23:42. Viewed 737 times.