Difference Between Bank Rate and Repo Rate
What is Bank Rate?
Bank Rate is the rate of interest which a central bank charges on the loans and advances to a commercial bank, without selling or buying any security. Whenever a bank has a shortage of funds, they can typically borrow from the central bank based on the monetary policy of the country.
- The loans are usually short-term loans lasting for just a day, or even just overnight. The bank rate is important because commercial banks use it as a basis for what they eventually charge their customers for loans.
- Policymakers use the bank rate to help them regulate the economy. In fact, it is one of the primary means policymakers use to try and effect economic changes.
- Policymakers can stimulate the economy by lowering the bank rate. This makes loans less expensive, thus encouraging borrowing, which expands the money supply and then spurs increased spending.
- When policymakers fear that the economy may be growing too rapidly increasing the risk of inflation, they may raise the bank rate. Raising the bank rate makes loans more expensive. This shrinks the money supply and reduces spending, which in turn, dampens the risk of inflation.
- Another important fact about bank rates is that these rates are used as a measure to structure the monetary policy of the economy. As the central banks control and manage the currency supply by altering the bank rates. When the unemployment rate in a country increases, the central bank of that country reduces the bank rate so that commercial banks offer loans at cheaper rates to the individuals. Note that such lending transactions do not involve any collateral.
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What is Repo Rate?
Repo Rate refers to the rate at which the Central Bank lends money to the commercial banks in case of a shortage of funds. It is basically used by Central Bank to keep inflation under control. When a commercial bank sells the security to Central Bank to raise money then banks promise to buy back the same security from Central Bank at a predetermined date with interest at the rate of REPO. It is actually a repurchase agreementRepurchase AgreementA repurchase agreement or repo is a short-term borrowing for individuals who deal in government securities. Such an agreement can happen between multiple parties into three types- specialized delivery, held-in-custody repo and third-party repo.read more.
- Policymakers use this in a similar way as bank rates to regulate the economy.
- Repo rate is one of the components of the monetary policy of the Central Bank which is used to regulate the money supply, level of inflation, and liquidity in the country.
- During high levels of inflation, attempts are made to reduce the money supply in the economy. For this, Central Bank increases the repo rate, makes it costly for businesses and industries to borrow money. This, in turn, slows down investment and reduces the supply of money in the economy. As a result, the growth of the economy is negatively impacted. However, this also helps bring down inflation.
- On the other hand, when the Central Bank needs to pump funds into the system, it lowers the repo rate which makes it cheaper for the businesses and industry to borrow money for different investment purposes. It also increases the overall supply of money in the economy. This ultimately boosts the growth rate of the economy.
Bank Rate vs Repo Rate Infographics
Here we provide you with the top 8 difference between Bank Rate vs Repo Rate
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Bank Rate vs Repo Rate – Similarities
- Bank Rate vs Repo Rate is fixed by Central Bank.
- Bank Rate vs Repo Rate is used to monitor and control the cash flow in the market.
Bank Rate vs Repo Rate – Key Differences
The key difference between Bank Rate vs Repo Rate are as follows –
- Meaning: Bank Rate is described as a rate of discount at which the Central Bank (RBI) extends loans to commercial banks and financial institutions. Repo Rate is described as a rate at which the Central Bank lends short-term loans to the commercial bank in case of shortages.
- Charged on: The bank rate is the rate of interest charged by the apex bank by the commercial banks for lending the loan whereas the Repo Rate is the interest rate charged on the repurchase of securities sold by the commercial banks.
- Type of Needs Served: Bank rates are used when the funds are required for long-term purposes whereas repo rates are used when the funds are required for short-term needs.
- Repurchase Agreement: In Repo Rate, the sale of securities to the central bank is as per a repurchase agreement, i.e. an agreement to buy back the securities at a predetermined rate and date in the future whereas in a bank rate, there is no repurchasing agreement; only the money is lent to banks and financial intermediaries at a fixed rate.
- Collateral: No securities are required to be provided to the apex bank as collaterals when funds are raised through exercising bank rates. However, in repo rate loan is granted to the banks only after collaterals are provided.
- Rate of Interest: The bank rate is used for long-term funds thus the interest is higher than the repo rate. Repo rate is lower than the bank rate.
Bank Rate vs Repo Rate Head to Head Difference
Let’s now look at the head to head difference between Bank Rate vs Repo Rate
| Basis of Comparison | BANK RATE | REPO RATE |
|---|---|---|
| Concept | Charged against loans offered by the central bank to commercial banks. | Charged for repurchasing the securities sold by the commercial banks to the central bank. |
| Interest Rate | Always higher than Repo rate | Lower than bank rate |
| Parties directly affected | It has a direct effect on the lending rates offered to the customer, restricting people to avail loans and damages the overall economic growth. | It is usually handled by the banks and doesn’t affect customers directly. |
| Collateral | No collateral is involved | Securities, bonds, agreements, and collateral are involved |
| Deals with | Bank Rate caters to long-term financial requirements of commercial banks | Repo Rate focuses on short-term financial needs. |
| Time Frame | The loan tenure under the Bank Rate is longer generally 28 days. | Being an overnight loan, the loan tenure under the repo is 1 one day |
| Repurchase Agreement | There is no repurchasing done here. | There exist a repurchasing agreement here. |
| Type of Tool | It acts as a tool to decide the long-term loan lending rates in the country. | It acts as a monetary tool to decide the liquidity rate in the banking system and control of inflation. |
Conclusion
- The Central bank of the country is an apex institution which is authorized to change and monitor the rates of Bank Rate and Repo Rate. Bank rate and Repo Rate are the elements of the monetary policy rates which are defined by the Central Bank of the country to control the lending rates by banks, inflation, and money supply in the country. Normally banks don’t borrow money from the central bank at “Bank Rate”. They resort to the central bank only if there is a severe shortage of funds.
- Bank Rate is a latent weapon to control the interest rate which, in turn, controls liquidity. However, Repo Rate is the topmost policy rate imposed by the Central Bank that acts as an anchor for the interest rate.
- Bank rate is merely a notional concept now. Hardly any banks resort to borrowing from the Central Bank at the bank rate. It is used when there is an imminent shortage of funds and indicates a long-term outlook on interest rates. Also, a repo agreement involves keeping government securities as collateral with the Central Bank, which can be repurchased once the loan is repaid. In India, the bank rate is generally 100 basis pointsBasis PointsBasis points or BPS is the smallest unit of bonds, notes and other financial instruments. BPS determines the slightest change in interest rate, to be precise. One basis point equals 1/100th part of 1%.read more higher than the repo rate.
- Though Bank Rate vs Repo Rate has its differences, both are used by Central Bank 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.
Bank Rate vs Repo Rate Video
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