News

Have You Discovered the Repo Rate?

22 Nov 2019 4 min read
News: Everything You Should Know About Repo rate & Reverse Repo Rate

Now and then there is a tremor in the money market. The financial pages of newspapers are buzzing with interviews and opinions on the state of the economy. The Reserve Bank of India earns some bouquets, but mostly it is brickbats that it has to duck. Then there will be long explanations about why the repo rate was hiked or cut. All will predict doom for the Indian economy, but one voice somewhere will justify it. All the noise dies down in a couple of days, and the common man continues as usual without a clue or whimper. Is he not affected? Maybe but he has no option when the powers-that-be have spoken. Mostly the poor common man does not understand why there is so much noise and what this wonderful thing called the repo rate impinges on his life.

What is a repo rate?

Repo rate stands for “repurchasing option.”

Let us explain what is the repo rate meaning.

When the common man is short of funds, he borrows from a bank. The bank will check his credentials as a borrower and then grant him a loan against collateral. A certain rate of interest will be imposed on the borrower. A period of time will be fixed in which the borrower has to return the money. The penalty will be predetermined in case the borrower is unable to repay the principal and interest on time.  This is the occurrence in the life of the ordinary citizen who is short of funds

But what happens if a bank is short of funds and cannot meet its obligations?

Banks go to the Reserve Bank of India to borrow funds. And here the repo rate comes into play.

The bank which borrows is bound by certain rules and rate of interest which it must pay to the Reserve Bank of India.

The bank also has to offer collateral to the RBI. The interest that the Reserve Bank of India charges is the repo rate. It keeps a check on inflation in the country by keeping a check on its banks.

How does repo rate work?

When a bank goes to the Reserve Bank for a loan, it has to agree to pay a rate of interest. It must also mortgage its treasury bills of equal value for the overnight loan. The agreement states that the treasury bills will be bought back by the bank at a predetermined rate.

Every bank is mandated to have a certain amount of liquid cash. Loans are given by the RBI against valid securities over and above mandated liquid cash or cash reserve ratio (CRR).

A part of the cash reserve ratio of every bank is deposited with the Reserve Bank to ensure a check on inflation. If the inflation level rises beyond a certain point, the central bank raises the cash reserve ratio to gain control over the spending of individual banks. When there is less to spend for the bank, individuals also find it difficult to get Personal loans.

In a nutshell repo rate is:

  • The rate at which the Reserve Bank of India lends money to banks
  • This method is used by the Reserve Bank to control inflation.
  • Banks sell their securities to the Reserve Bank and buy them back at a predetermined rate at a later date.

What is a repo rate and how it affects the economy of India?

The repo rate is a way to control the economy in India. It controls the rate of interest banks charge their customers. When the repo rate is high, the banks charge their customers a higher rate of interest. The repo rate controls the money supply, the rate of inflation, and liquidity.

When the inflation rate is high, the Reserve bank tries to restrict the money supply in the market. This is done by hiking the repo rate. When the repo rate is high, fewer loans are taken by industrialists and businessmen. There is less investment made, and therefore, there is less money in the market.  The negative impact of this is felt in the slowing down of the economy. But it also brings down the rate of inflation.

How does the repo rate affect the struggling Indian?

Today India has an upwardly mobile population. Indians aspire to own white goods, give their children a good education and above all, they aim to own their dwelling. Most people have to knock on the doors of a bank to make this aspiration a reality. Fortunately, for this generation, home loans are easier to get today than they were a decade ago. The government policy has also helped because the rate of interest has been kept in check. Lending by banks is much more, so building activity has shown an upward trend. A huge number of builders in the market are vying for the custom of the common man. Having taken a loan, the borrower who does not know the repo rate is affected by it.

Impact of the current repo rate

When the Reserve Bank of India raises its repo rate, borrowing from banks becomes costlier for individuals, businessmen, and industrialists. Repo rate has been recently revised by 25 basis points. It now stands at 6.25%. This was because of controlled inflation, which has stayed below 4% for six months. It is expected that it will be contained in the next six months also. This cut in the repo rate is expected to give a fillip to industrial growth and boost the economy.

The RBI changes its interest rates according to economic factors. Whenever the repo rate is changed, it leaves a mark on all spheres of the economy. Some of the effects are positive, and some impact the economy negatively.  Even when the Reserve Bank lowers the repo rate, it is not necessary that the banks pass down the benefit to their borrowers. A hike makes borrowing costlier, but the reverse does not always happen. 

In a sense, repo rate and economic growth are interdependent and indicate the state of health of the economy of India.

Repo VS Reverse Repo rate of RBI

When a bank deposit its surplus cash with RBI for a short period, then RBI offers reverse repo rate. We can also say it is a type of interest rate that RBI pays when it borrows money from the commercial banks. Usually, banks deposit the surplus fund mostly, when they don’t have any lending or investment options.

RBI also encourages banks to invest more cash, lying idle.

Repo Rate

Reverse Repo Rate

It is defined as the rate at which commercial banks borrow money from RBI

It is defined as the rate at which RBI borrows money

Interestingly, Repo rate is higher than reverse repo rate

Reverse Repo Rate is somewhat lower than Repo rate

This is used to control inflation.

Reverse Repo Rate controls the supply of the money

Repo Rates Current and Over a Decade

06th Jun 19

5.75%

04th Apr 19

6.00%

07th Feb 19

6.25%

05th Dec 18

6.50%

05th Oct 18

6.50%

01st Aug 18

6.50%

06th Jun 18

6.25%

05th Apr 18

6.00%

07th Feb 18

6.00%

06th Dec 17

6.00%

04th Oct 17

6.00%

02nd Aug 17

6.00%

08th Jun 17

6.25%

06th Apr 17

6.25%

08th Feb 17

6.25%

07th Dec 16

6.25%

04th Oct 16

6.25%

05th Apr 16

6.50%

29th Sep 15

6.75%

02nd Jun 15

7.25%

04th Mar 15

7.50%

15th Jan 15

7.75%

28th Jan 14

8.00%

18th Dec 13

7.75%

29th Oct 13

7.75%

20th Sep 13

7.25%

19th Mar 13

7.50%

29th Jan 13

7.75%

17th Apr 12

8.00%

25th Oct 11

8.50%

16th Sep 11

8.25%

26th Jul 11

8.00%

16th Jun 11

7.50%

03rd May 11

7.25%

17th Mar 11

6.75%

25th Jan 11

6.50%

02nd Nov 10

6.25%

16th Sep 10

6.00%

27th Jul 10

5.75%

02nd Jul 10

5.50%

20th Apr 10

5.25%

19th Mar 10

5.00%

21st Apr 09

4.75%

05th Mar 09

5.00%

05th Jan 09

5.50%

08th Dec 08

6.50%

03rd Nov 08

7.50%

20th Oct 08

8.00%

30th Jul 08

9.00%

25th Jun 08

8.50%

12th Jun 08

8.00%

30th Mar 07

7.75%

31st Jan 07

7.50%

30th Oct 06

7.25%

25th Jul 06

7.00%

24th Jan 06

6.50%

26th Oct 05

6.25%

As evident from the above table, RBI has slashed 25 bps repo rate, making the current Repo Rate to 5.75% from 6% on 6th June, 2019. The change in rate, will change the MCLR and hence likely to slash down the bank rates. Consumers! Its time to smile. This is the third time, when BI has slashed the REPO Rates.

RBI Governor Shaktikanta Das says, “It's our expectation that as we go forward there will be higher transmission and then there will be faster transmission as well. This transmission will find its impact on individual consumer loans, consumer durable loans and two-wheeler loans as well.” 
 

Graph of REPO Rate