‘What is Repo Rate? And how does it impact you?’ is a part of the series where we discuss some of the measures the Reserve Bank of India takes to control Inflation, credit availability, and economic growth. Previously, we have discussed CRR and SLR. However, all these ratios and rates are the parts of the monetary policy of the Reserve Bank of India to manage the interest rates and money supply in the economy.
This post contains the following:
- What is Repo Rate?
- How does Repo Rate work?
- How does the Reserve bank of India use it?
- The bottom line
What is Repo Rate?
The banks take loans from the Reserve Bank of India whenever required. However, they have to pay interest for that, just like we do. That is called Repo Rate. Thus, Repo Rate is nothing but the interest rate banks have to pay to the Reserve bank of India when they take a loan. It comes in a percentage form. It changes from time to time.
Follow the process to check the current Repo Rate: https://www.rbi.org.in/ ≫ Current Rates Policy ≫ Repo Rate
We also call the Repo Rate as ‘Repurchasing Option’. Why is it called so? To get the answer, we have to see how it works.
How does Repo Rate work?
The Reserve bank of India gives only secured loans. As you know, secured loans are backed by collateral. Thus, the banks have to keep government securities with the RBI as collateral to take a loan. Further, they promise the Reserve bank of India to repurchase the government securities after the Repo period. Generally, the average Repo period refers to one week. That means the banks agree to repurchase the government securities in one week. Therefore, we call Repo Rate as the Repurchase Option also. However, there is no restriction on the maximum repo period in an open repo.
Suppose a bank named ‘ABC’ requires Rs 100 Crore loan from the Reserve bank of India, then it has to give government securities worth of Rs 100 Crore as collateral. Further, it agrees to repurchase the government securities in one week. If the Repo Rate during the period remains at 4%, then the bank has to pay Rs 1,00,07,67,123 (Rs 1,00,00,00,000 plus an interest amount of Rs 7,67,123 for those 7 days) and repurchase the government securities. That’s a simple deal.
How does the Reserve bank of India use it?
The Reserve bank of India uses Repo Rate as a tool to control Inflation or push an economy. Let’s see how?
In the event of slower economic growth, the Reserve bank of India lowers the Repo Rate. In other words, banks get loans at a cheaper rate. It enables banks to disburse loans at a more affordable interest rate to their customers. As a result, people tend to take loans. Thus, more money flows into an economy.
Further, more money chases more products and services, and the prices of goods and services go up. It also causes the Inflation rate to go up. As a result, it spurts a slower economy.
Note: A moderate rate of 2-3% Inflation growth is beneficial to an economy.
On the other hand, to control the Inflation rate, the Reserve bank of India raises the Repo Rate. That way, the banks have to pay more interest on their loans to India’s reserve bank. Therefore, they also increase the base rate.
Note: A Base Rate is a minimum rate set by the RBI under which banks are not allowed to lend to their customers.
To check the current Base Rate follow the instruction: https://www.rbi.org.in/ “Current Rates “Lending/Deposit Rates
An increase in the base rate results in a higher interest rate for borrowers. As a result, people don’t like to take loans. It reduces the money flow into an economy. Further, less money in an economy causes a lesser demand for goods and services. As a result, the prices of products and services go down, and the Inflation rate is controlled.
It is how the Reserve bank of India manages the money supply to control Inflation or push the button of economic growth.
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TABLE – 1
The bottom line
A person who wants to manage his or her own money needs first to understand a few basic concepts. Inflation comes under those basic concepts. For example, whenever a person needs to set his or her financial goal, he or she must take into account the ‘Inflation’ factor. Considering the importance of the Inflation factor in personal finance, we have introduced you to its related topics also so that you can understand it in a better way. Therefore, we have tried to cover everything from ‘Inflation’ to ‘Repo Rate.’
The Repo Rate impacts the rates of interest directly. Thus, understanding these concepts will empower you and help you to make better decisions. Once you master it, you can predict the forthcoming changes that will happen after a careful observation of the current economic situations. It can create more value in your financial life.
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Thanks and regards,