Repo Rate vs. Bank Rate

Repo rate and Bank rate are two of the most commonly used rate by the RBI and commercial banks for transactions between the central banks and other domestic banks. Although the bank rate and repo rate are considered to be the same concept by many commoners, it's factually incorrect to consider the terms to be similar.

The bank rate is used by the domestic/commercial banks when they borrow any money from the central bank, and domestic/commercial banks take these loans due to the anticipated shortage of funds in the banks. Repo rate, on the other hand, is also known as the repurchasing rate and it is used in banking transactions and repurchasing agreement. The central bank sells its securities to the commercial banks and makes a contract of repurchasing the securities from the banks in a later period with a predefined price. One of the significant difference between bank rate and repo rate is that the bank rate has a direct effect on the lending rates offered by the commercial banks to the clients. The interest rate that is used for these securities is known as repo rate or repurchase rate.

The RBI announced the change in bank rate and repo rate in June 2018. This announcement was made as a part of the second bi-monthly monetary policy statement of RBI. The bank rate was increased from 6.5% to 6.75%, an increase of 25 basis points and the repo rate has been increased from 6.25% to 6.50%

The repo rate and bank rate are used to regulate the money supply in the economy. If the repo rate is high, the commercial banks will purchase fewer securities from the central bank and the financial institutions will also get their fundings at a higher rate. At the same time, if the repo rate is low, the money supply in the economy will expand, and the financial institutions get their fundings at a relatively lower rate.

Difference Between Bank Rate and Repo Rate

The primary difference between bank rate and repo rate is that bank rate usually deals with loans extended by the RBI while the repo rate is the rate at which the securities are repurchased. In the bank rate, there is no collateral, but in case of repo rate, the repurchase agreement designed by the central bank uses the securities as collateral.

The trends over many years suggest that the repo rate is always lower than the bank rate.

Repo rate is used to cater to the short-term requirements of the commercial banks. By increasing the repo rate, the central bank tries to decrease the cash flow in the economy. However, the significant difference between bank rate and repo rate is such that a change in repo rate doesn't change the market rate of interest. But, a change in bank rate can affect the lending rates in the economy. If the bank rate is high, then the rate of interest charged by the central banks for extending long-term loans to the domestic banks is raised. Since the funds expended by the RBI to the commercial bank is meant for long-term funding, the burden of a rise in the bank rate is passed on to the customers, and then it ultimately raises the market rate of interest.