Banking terms in news: Repo Rate

About:

  • Repo rate is the rate at which the central bank lends to the commercial banks in case of any shortfall of funds.
  • Derived from the word “Repurchase“.
  • So, the literal meaning of the Repo Rate is- ” The rate at which the commercial banks repurchase the securities that they have kept with the RBI in the case of shortfall of funds”.
  • Represented in “percentage” or “basis points”(Basis Points= Percentage*100; eg. 1%=100 basis points; generally, basis points is used to show the difference between the rates or to show rate cuts; eg. RBI cuts the RR by 25 basis points means 0.25% rate cut).
  • It is an important Monetary Policy tool.
  • Governed by RBI.

Purpose:

  • Major purpose is to control inflation.

Significance:

More or less the significance of all the monetary policy tools is similar.

  • Repo rate is the rate at which RBI lends the commercial banks. So, this rate would decide the interest rate on the loans offered by the commercial banks.
  • Thus, it has a considerable bearing on the investment and growth.
  • Repo rate has become the cornerstone of the Indian monetary policy.

Conceptual Understanding:

  • If Repo rate is increased:
    • Costlier loans.
    • Lesser lending or in other words, lesser will to borrow.
    • Liquidity: likely to decrease.
    • Inflation: likely to decline.
    • Domestic investment: likely to fall.
    • Growth rate: may slow down.
  • If Repo rate is reduced:
    • Cheaper loans.
    • Greater lending due to greater will to borrow.
    • More liquidity in the market.
    • Inflation: increase.
    • Domestic investment: likely to increase.
    • Growth rate: may pace up.

Current Repo rate: 

6.5% .

Issue:

One core issue related to the REPO RATE is the lack of transmission of the rate cuts to the borrowers by the commercial banks.

The major reasons being increasing NPAs, compliance to the BASEL 3 Norms, recovery of losses among others. (This will be covered comprehensively after covering the related aspects for better understanding).

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