Meaning of Repo Rate
The rate at which the central bank of any country, the Reserve Bank of India in the case of India, lends money to commercial banks in the scenario of any shortage of funds is called Repo Rate.
The controlling Repo Rate can have an effect on inflation and the authorities and governments use Repo Rate to moderate and control inflation. If the country is hit by inflation, the central banks increase the repo rate as this serves as a deterrent for commercial banks from borrowing money from the central bank. This ultimately reduces the money supply and availability in the monetary economy and thus helps in keeping inflation at bay.The central banks take the opposite stand in the event of an inflationary fiasco and pressures.
Repo rate and reverse repo rates are a part of the process and a facility of liquidity adjustment. The word REPO means an alternative to purchase or an option of repurchase. This monetary instrument is used by central banks to control the availability of funds to commercial banks.
The rate at which the Reserve Bank makes funds available is called repo rate. The commercial banks borrow money from the central banks against treasury bills and government bonds.
Repo rates are fixed and changed with the changing policies and processes of the central banks. When in an event where the commercial banks experience a shortage of cash they may approach the central banks for help, in turn depositing government bonds and collaterals. The borrowed money is subject to rates of interest regulated by the central banks, the commercial banks repay this money according to this rate fixed by the RBI, when the loan amount is repaid the bonds deposited as collateral are repurchased.
The most important monetary control instrument the RBI has in its reserve is the repo rate. With the help of the repo rate the central bank regulates inflation and unevenness in the economy. Thus it is understandable that the repo rate changes according to the changes and the undulations in the economy of the country. This is also an instrument by which the money present in the economy can be monitored and accounted for.
The commercial banks are ample affected and their credit costs are also affected with the change in repo rate. This affects the interests on home loans, bank credit etc. it is also called repurchase rate .
How does the repo rate function?
Interest is paid by borrowers to banks on loans, this is a mandatory and principal process. A colloquial term used for this is cost of credit.
In a dire situation of a cash shortage these commercial institutions borrow money from the Reserve Bank on the principal of collateral deposits like government bonds and securities. These bonds and securities are repurchased by the banks after the principal loan amount is repaid. It is a repurchase agreement in which the commercial banks bring forth securities such as Treasury Bills to the RBI in return for short-term funds and loans.
Importance of repo rate
Repo rate is an important part and ingredient of the monetary policy implemented by the nation, and it is used primarily to regulate the liquidity of money, inflation, and money supply in the country. Along with this, repo rate values create a direct impact on the pattern of borrowing by commercial banks and financial institutions.
In order to explain, we must understand the situations of increased repo rate, the banks need to pay increased rates of interest to RBI in order to avail borrowed funds, but when the rate is not high, that is, in terms of lower repo rate, the cost of borrowing funds is less. This is the way in which inflation can be controlled.
The impact of repo rate in the country
- At the time of high inflation : At times of high inflation in the economy of a country, the central bank (RBI) regulates the supply of money in the economy by increasing the repo rate by a considerable amount, which in turn results in lesser borrowings by the commercial banks and the financial institutions.
The result of this acceleration of the money supply slows down investment activities in the economy, which is of utmost importance in controlling the inflation rate.
- In order to increase liquidity in the economy: When there arises a requirement of increasing seamless liquidity in the market, RBI lowers the repo rate so that financial institutions can borrow money for investment purposes, which results in an accentuated increase of money supply in the economy.
The effect of this change in the repo rate is that it becomes instrumental in the growth of the economy.
Thus the repo rate is a monumental weapon in the economic arsenal of the country.