Definition
Bank Rate is the interest rate at which a country’s central bank lends money to domestic banks, often to control inflation and stabilize the country’s financial system. The Repo Rate, on the other hand, is the rate at which banks borrow money by selling their securities to the central bank to maintain liquidity. Whereas the Bank Rate deals with long-term lending, the Repo Rate is for short-term borrowing.
Key Takeaways
- Bank Rate and Repo Rate are tools used by central banks to control liquidity in the economy. Bank Rate refers to the rate at which a nation’s central bank lends money to domestic banks, while the Repo Rate refers to the rate at which central banks lend money to commercial banks for a short period in exchange for government bonds.
- They are used to control inflation and stabilize the economy. A decrease in these rates can stimulate economic growth by making borrowing cheaper, while an increase in these rates can help control inflation by making borrowing more expensive.
- The main difference between the two is that the Repo Rate involves the sale of securities with an agreement to repurchase them at a specified later date, whereas the Bank Rate does not involve any such collateral.
Importance
The distinction between a bank rate and a repo rate is vital in the financial sector because these rates are tools used by a country’s central bank to control monetary policy, liquidity in the market, and economic stability.
The bank rate, also known as the discount rate, is the interest rate charged by the central bank to commercial banks for loans obtained without providing any collateral and often impacts the interest rates that banks offer to their customers.
On the other hand, the repo rate is the rate at which commercial banks borrow short-term money from the central bank by selling securities with an agreement to repurchase them at a future date.
Changes in these rates determine the cost of borrowing for banks, which in turn affect inflation, economic growth, and the overall financial climate of a country.
Thus, understanding the distinction and interplay between these two rates is essential for economic forecasting and financial planning.
Explanation
Bank Rate and Repo Rate are tools used by central banks, like the Federal Reserve in the United States or Reserve Bank of India, to manage the money supply in the economy, affecting liquidity, inflation, and economic growth. The Bank Rate, also known as the discount rate, is the interest rate charged by the central bank to commercial banks for loans extended to them. This rate becomes significant in determining the lending rates set by banks for their customers.
A higher bank rate would make borrowing expensive for commercial banks, leading to higher lending rates for customers, thus encouraging savings and curbing inflation. On the other hand, the Repo Rate is the rate at which the central bank of a country lends short term money to the commercial banks against securities. When the repo rate increases, borrowing from the central bank becomes more expensive.
Conversely, if the central bank reduces the repo rate, it allows banks to borrow at cheaper interest rates. This rate is used to control inflation and manage liquidity in the market. So, if the economy is faced with inflation, the central bank might increase the repo rate, making it more expensive for banks to borrow funds, thus forcing them to increase their own lending rates, which slows consumption and cools the economy.
Examples of Bank Rate vs Repo Rate
The Federal Reserve (central bank in the United States) Manipulating Interest Rates: The Federal Reserve uses the Federal Funds Rate (equivalent to the repo rate) as a primary tool to control the US economy. For example, during the 2008 financial crisis, it slashed this rate nearly to zero to stimulate borrowing and investment. Simultaneously, the bank rate, or the rate at which commercial banks lend to consumers and businesses, also dropped, although not as much, due to the risk involved in lending to these entities.
Reserve Bank of India (RBI)’s Action to Tackle Inflation: In 2014, to curb inflation, the RBI raised its repo rate (the rate at which it lends to other banks), which in turn caused commercial banks to increase their bank rate (the rate they charge to customers). By increasing the cost of borrowing, the intention was to reduce consumption and control inflation.
Bank of England (BoE)’s response to Brexit: In 2016, following the Brexit vote, the BoE cut its bank rate from
5% to
25% to ease economic uncertainty. This led to cheaper borrowing costs for consumers and businesses in an attempt to stimulate the economy. The repo rate, which is used in transactions between the central bank and commercial banks, was also adjusted accordingly, although they do not always have to mirror each other.
Frequently Asked Questions: Bank Rate vs Repo Rate
What is Bank Rate?
Bank Rate is the rate of interest at which the central bank of a country lends money to its commercial banks without any collateral security. This means it’s a tool that central banks use to control the liquidity of money in the market and thereby control inflation.
What is Repo Rate?
Repo Rate is the rate at which a country’s central bank lends money to commercial banks for a short period, against securities. When the repo rate increases borrowing from the central bank becomes more expensive. Therefore, repo rate is used as a tool by monetary authorities to control inflation.
What is the main difference between Bank Rate and Repo Rate?
The main difference between the two is that Repo Rate involves selling securities to the central bank and agreeing to repurchase them at a fixed rate. Conversely, Bank Rate is a long term measure and involves no such buying or selling of securities.
What happens when Bank Rate and Repo Rate are increased?
When Bank Rate and Repo Rate are increased it becomes more costly for commercial banks to borrow from the central bank. This subsequently leads to higher borrowing costs for consumers, decreasing demand for loans and eventually leading to lower inflation.
How do Bank Rate and Repo Rate affect the common man?
The Bank Rate and Repo Rate have a direct impact on the lending rates that commercial banks set for their customers. When these rates are high, commercial banks increase their own interest rates for customers. This makes loans expensive for the common man, and vice versa when the rates are low.
Related Entrepreneurship Terms
- Monetary Policy
- Central Bank
- Liquidity Adjustment Facility (LAF)
- Inflation Control
- Open Market Operation
Sources for More Information
- Investopedia: A comprehensive source for investment and financial education content.
- The Balance: It provides expertly crafted content to help you understand bank rate and repo rate.
- Bankrate: A platform providing insights, professionally vetted by experts to simplify complex financial concepts.
- The Economic Times: This site provides updates and insightful news articles about global economic events, including information about bank rate and repo rate.
