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Repo Rate

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Aakash Jain

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What is a Repo Rate?

Repo stands for ‘repurchasing option’. In India, RBI offers funds in exchange for securities to commercial banks that require urgent cash. The repo rate is the interest charged at the time of repurchase of the sold securities. This helps RBI regulate and curb inflation. 

This rate fluctuates as per the policies of RBI and prevalent market conditions. The central bank’s Monetary Policy Committee (MPC) meets every 3 months to reflect on the need to increase or decrease the repo and other important rates. If no cuts or boosts are required, RBI’s MPC tends to keep these unchanged.

Cuts in repo rates allow commercial banks to get loans from RBI at lower interest rates, while a hike results in the exact opposite. The effects of changes in the repo rate trickle down to your personal finances as well. If it is lowered, your home loan might be impacted by a reduction in the interest you are liable to pay and vice versa.

How Do Changes in Repo Rates Affect You?

You might be wondering how in the grand scheme of things can the repo rate affect your finances? Well, a repo rate affects your loan EMI payments. An increase in the repo rate can make your personal loan, home loan, and other loan EMIs, more expensive. Similarly, if it were to decrease, your monthly instalments are likely to become cheaper as well. 

The reason for this is that a bank decides your interest rate based on an MCLR as determined by RBI. When there is a fluctuation in the repo rate, the changes may be reflected in the MCLR as well, to help balance the overall economy. A change in the MCLR is likely to result in a change in your loan’s floating interest rate.

Additionally, when the repo rate is lowered, banks can potentially borrow more money at cheaper rates from RBI. This easy availability of funds increases the commercial banks’ lending ability, making loans cheaper.

Difference Between Repo Rate, Reverse Repo Rate, and MCLR

Let us understand the repo rate better by comparing it with two other prominent rates, which it is often confused with. Here are the differences between the repo rate, reverse repo rate, and MCLR.

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Repo Rate

Reverse Repo Rate

MCLR

Concept

The rate at which RBI lends money to banks, by holding their securities and assets as collateral under a repurchase agreement.

The rate at which RBI borrows money from banks.

The minimum reference rate determined by RBI, based on which a bank computes its lending rate.

Rate

Higher rate than the reverse repo rate. Currently, at 6.00%.

Lower rate than the repo rate. Currently, at 3.35%.

Usually higher than the repo rate. Currently, at 8.15% - 8.45% (overnight).

Purpose

Controls the rate of inflation in the economy.

Ensures management of cash flow.

Brings transparency and uniformity to bank interest rates.

Function

Involves the sale of securities to RBI by banks.

Involves the transfer of money from banks to RBI.

Used as a benchmark by banks to determine their lending rates

Conclusion

Repo rate plays an essential role in maintaining cash flow, liquidity and stability in the overall economy. Furthermore, it also plays a vital role in your personal finances. The repayment of all types of loans, including home loans, can be impacted by a slight change in the repo rate. Therefore, it is essential to always have an eye out for any revisions made to this rate.

FAQs

Repo rate
What is the difference between a repo rate and reverse repo rate?

A repo rate is a rate at which RBI lends funds to a commercial bank, while the reverse repo is the exact opposite. A reverse repo is the rate at which RBI borrows money from banks. This is usually done in an attempt to control cash flow and maintain the right level of liquidity in the market.

Following the launch of the RBI guideline in 2019, commercial banks introduced home loans based on Repo Linked Lending Rate (RLLR) models. Under this, the floating interest rate is directly linked to the repo rate determined by RBI. For example, if the repo rate is cut from 6.50% to 6%, a similar 50 bps deduction will be noted in the interest rate of your home loan as well. 

The Statutory Liquidity Ratio (SLR) is the percentage of the minimum amount a bank is required to maintain in the form of financial securities. On the other hand, the Cash Reserve Ratio (CRR) is the percentage of money that a bank has to deposit with the RBI. The CRR and SLR are reserve ratios determined by RBI, that help ensure banks have constant cash flow, even during inflation.

Repo transaction also known as repo repurchase agreement requires banks to rebuy the securities sold to RBI for extra funds during emergencies. Under such transactions, the banks are required to repay the amount, along with the interest as per the repo rate. These securities are usually held by RBI on an overnight basis. 

When the repo rate is lowered, banks can potentially borrow more money at cheaper rates from RBI. This easy availability of funds increases commercial banks’ lending ability, making loans cheaper. Additionally, a cut in the repo rate may be reflected as a cut in the MCLR. This leads to a drop in the EMI you pay on loans with floating interest rates, which are closely linked to your MCLR. 

Here is how the repo rate impacts the economy of India:

  • Affects the cash flow and inflation rates in the country

  • Lower rate reduces borrowing costs, enabling businesses to borrow more

  • Influences market liquidity and economic growth

Revisions in the repo rate can help control liquidity in the economy, manage inflation, and avoid the impact of geo-political tensions and recession.

RBI calculates the repo rate based on the economy's inflation rate. High inflation leads to an increased repo rate to curb borrowing and reduce money supply. Low inflation prompts RBI to lower the repo rate, making borrowing easier and increasing the supply of funds in the market. These adjustments aim to control inflation and stabilise the economy.

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Hi! I’m Aakash Jain
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Aakash is a seasoned marketing and finance professional with over five years of experience. With a unique blend of financial expertise and creative flair, he excels in crafting succinct, user-friendly content that empowers readers to make well-informed choices. Specialising in articles, blogs, and website pages for loan products, Aakash is dedicated to simplifying complex concepts and delivering valuable insights that resonate with diverse audiences.

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