Bank Rate vs Repo RateDifferences You Need to Know Between the Two!

A key function of the central bank is to conduct monetary policy to maintain price stability as well as control inflation.

One of its goals is to stabilize the nation’s currency.

Inflation is inevitable, but it’s not like its effect can’t be minimized.

Among the tools that the central bank uses to regulate the flow of money are the bank rate and the repo rate.

These two are interest rates that the central bank uses in its borrowing and lending activities.

These two rates also aid the central bank in controlling inflation as well as maintaining liquidity in the market.

As such, they are often considered to be one and the same.

However, the bank rate and repo rate are two different things.

For example, one of the two rates affects the interest that commercial banks charge to their customer’s borrowings.

The other only concerns the borrowings between the central bank and the commercial banks.

There’s more to it than just that though.

We will be discussing what the bank rate and repo rates are, then make a comparison between the two.

What differentiates one from the other?

Let’s find out.

 What is Bank Rate?

The bank rate is the rate that the central bank charges on loans and advances that they extend to commercial banks.

These loans and proceeds generally do not require any collateral.

Whenever a commercial bank experiences a shortage of funds, it always has the option to borrow money from the central bank. The bank rate applies for such borrowing.

The bank rate is one of the tools that policymakers use to regulate the economy.

Lowering the bank rate usually stimulates the economy. A lower bank rate makes borrowing cheaper.

This in turn encourages people to borrow money for spending.

When the policymakers want to control the circulation of money, they increase the bank rate.

By reducing the supply of currency in the market, the central bank can control inflation (to an extent).

The bank rate influences the interest that commercial banks charge on loans to their customers.

When there is an increase or decrease in the bank rate, the whole economy feels it.

As such, it is a powerful tool that policymakers can utilize to try and implement economic changes.

For example, when the unemployment rate is high, the central bank might opt to lower the bank rate.

This in turn allows commercial banks to offer loans at cheaper rates to individuals.

What is Repo Rate?

“Repo” is short for the term “repurchase”, meaning that repo rate also means repurchase rate.

As the name implies, the repo rate is the rate used for the repurchase of securities by the government that previously issued them.

The repo rate also applies to the short-term borrowing of a bank from the central bank to address a shortage of funds.

This type of borrowing involves keeping certain securities as collateral.

The repo rate is mainly a tool to maintain liquidity in the banking sector.

The central bank will decrease the repo rate if it wants to increase the liquidity in the banking sector.

In contrast, if it wants to decrease the liquidity in the banking sector, it will increase the repo rate.

The repo rate is also a great tool for addressing inflation.

During high levels of inflation, the central bank would want less money circulating in the market.

To do this, the central bank will increase the repo rate which discourages banks from borrowing.

Consequently, it reduces the money supply, but it helps in bringing down inflation.

If the central bank wants to boost the economic growth rate, it would want to increase the money supply.

By decreasing the repo rate, banks are encouraged to borrow from the central bank.

This in turn increases the money supply which can result in a boost in the economic growth rate.

Bank Rate VS Repo Rate

Here are some of the key differences between the bank rate and repo rate:

Definition

The bank rate refers to the discount/interest rate on loans that the central bank extends to banks and other financial institutions.

On the other hand, the repo rate refers to the rate the central bank uses for the repurchase of securities.

It also relates to short-term loans that the central bank extends to commercial banks during shortages.

Charged on what?

The bank rate is the interest rate that the central bank applies on loans to banks and other financial institutions.

In turn, it affects the interest that said banks charge on loans to customers.

The repo rate is the interest rate that the central bank charges on repurchases of securities that commercial banks sell.

Types of Needs Served

The bank rate applies when the proceeds of the loan are intended for long-term purposes.

On the other hand, the repo rate applies when the proceeds of the loan or advance are for short-term needs, such as to address a shortage of funds.

Repurchase Agreement

In a borrowing where the repo rate applies, there is a repurchase agreement.

Meaning that there is an agreement to buy the securities at a certain rate and date in the future.

In a borrowing where the bank rate applies, there is no involvement of a repurchase agreement.

The loan is solely to lend money to banks and other financial institutions at a fixed rate.

Collateral

For loans where the bank rate applies, the central bank does require any collateral.

But for loans where the repo rate applies, the repurchased securities act as the collateral.

If the borrowing party cannot provide collateral, it cannot avail of a loan that uses the repo rate.

Interest Rate

The bank rate tends to be higher than the repo rate.

The bank rate usually applies for long-term loans, and as such, may demand a higher rate.

On the other hand, the repo rate applies for short-term loans, which is why it tends to be lower than the bank rate.

Affected Parties

Increasing or decreasing the bank rate affects not only the banks but also the customers and the economy as a whole.

This is because the bank rate affects the interest rate that banks charge on loans to their customers.

On the other hand, the repo rate only affects the central bank and the concerned banks.

It doesn’t affect the general public.

The bank rate has a greater impact on the economy than the repo rate.

In Conclusion

The bank rate and repo rate are among the tools that the central bank uses to regulate the economy.

They are both useful tools for controlling inflation, liquidity as well as the money supply.

That said, they have their differences, and they matter.

They apply for different kinds of loans.

They also have different levels of impact on the overall economy.