What Is Repo Rate? How Does the Repo Rate Affect Emis?

Repo rates are the rate at which commercial banks borrow a certain amount of money from the central bank of our country which is the Reserve Bank of India (RBI) after selling the securities to RBI. The borrowed money helps banks in maintaining liquidity in case they lack necessary funds or due to any kind of statutory issues. Repo rate act as the primary tool of RBI that keeps inflation under control.

What makes the repo rate work efficiently?

After we borrow money from our banks, the transactions facilitate interest accumulation based on the principal amount. This is called as cost of credit. Likewise, when these banks borrow money from the central bank of India during any crash emergency, they have to pay RBI a certain rate of interest fixed annually. This interest rate is the repo rate that is fixed for every Indian commercial bank.

The technical term for the repo is ‘repurchasing option’ or ‘repurchase agreement’. The agreement is made between banks and RBI so that banks can receive loans by providing their eligible securities like Treasury bills to the RBI. An agreement to repurchase also has the predetermined price while repurchasing the securities back. Therefore, the banks get desired money while RBI keeps the securities.

Who decides the Repo Rate?

In India, the repo rate is decided by the RBI governor, the chairperson of the committee and the Monetary Policy Committee. Together they decide the repo rate each year based on the fiscal and inflation projections.

Important Components of a Repo Transaction

Before sanctioning money or keeping securities some important parameters are considered by the RBI executives following which transactions are made further.

Preventing squeezing of the economy: The RBI increase or decrease repo rates every year to control economic inflation. Therefore, it aims at controlling the country’s economy by limiting inflation rates.

Leveraging and hedging: the central bank of India aims to leverage and hedge by buying bonds and securities from commercial banks and in return, provide them with cash in lieu of collateral deposits.

Short-term borrowing: The money is lent by the RBI for a short term, the maximum being overnight after which the banks have to buy their securities back at a predetermined price.

Securities and collaterals: the collaterals in the form of bonds and gold only can be accepted by RBI.

Liquidity or cash reserve: the money is borrowed by the banks to maintain cash reserve or liquidity like a precautionary measure.

Does the repo rate affect the economy?

As discussed earlier, the repo rate is one of the powerful tools used while making monetary policies, it regulates India’s money supply, liquidity and inflation level. Other than this, the repo rate can impact the cost of borrowing directly for banks. This means, higher is the repo rate, the more will be the cost of borrowing for banks and vice-versa.

Rise in inflation

When the inflation rate is high, the RBI attempts to bring down the flow of money by increasing the repo rate. This makes money borrowing costs higher for industries and businesses which in turn slows the investment and money supply in the marketplace. These further impacts growth of the economy negatively which helps in controlling inflation rates. 

Increasing liquidity

Alternatively, when RBI seeks to pump up funds in the market, they lower the repo rate. This makes industries and businesses find cheap money borrowing rates to invest in different sectors. By lowering the repo rate, the money supply in the market increases and ultimately boosts the country economy.

What is Reverse Repo Rate

Reverse Repo Rate is contradictory to repo rate and acts as an important tool to absorb excess liquidity in the market. The reverse repo rate restricts the borrowing power of investors. A reverse repo rate occurs when the RBI borrows money from commercial banks when the market has excess liquid money. The banks then benefit from borrowing money by getting interest for their holdings kept in the central bank.

When the inflation rates are higher in an economy, the central bank increases the reverse repo rate. This encourages banks to park funds with the RBI and earn high returns for excess funds. Thus, banks are left with lesser funds and discourage loans or borrowings to their customers.

Can repo rate affect you?

Till now, you must have known that repo rates remove excess money supply from the market. Thus, when RBI increases the repo rate, commercial banks have to pay more interest and borrowing money for loans is discouraged by them. This further discourages industries and businesses to borrow money from banks at high rates. Rather, they prefer depositing money in the bank and control liquidity in the market. When the repo rate is reversed, the effect is the opposite. In short, if you are working in corporate or have your businesses, increasing repo rate means you will get less money borrowing opportunity as compared to reverse repo rate that attracts money investments.

How does the repo rate affect EMIs?

More often you must have heard about RBI cutting the repo rate interest down or increasing the repo rate. Well, if the repo rates are decreased by RBI, it is always good news for commercial banks. So, does it affect our EMIs and is it beneficial for us?

Before understanding how our EMIs are affected due to repo rates, let’s know how repo rate works for EMI calculations. Ideally, a low repo rate must be translated as low-cost loans for the general population. This is because when RBI reduces repo rates, it expects commercial banks to charge less interest against loans. In this sense, if you seek a loan during the lessened repo rate period, you may have to pay fewer interest rates and gradually, the cost of EMI is reduced.

Similarly, when the repo rate is increased by the RBI, the loans become costlier for us due to a hike in loan interest rates. This is due to commercial banks have to acquire funds from RBI at a higher price that forces them to increase money borrowing rates.

But then, you must also know that such scenarios do not work like that every time. It has been observed lately that whenever RBI reduces the repo rate, banks take a certain time to decrease their lending rates. But when the repo rate is increased, banks respond to it quickly and increase the borrowing rate as soon as possible.

This is the reason RBI has introduced an MCLR system to alter the ways in which commercial banks function. Today, commercial banks in India have to publish their proposed interest rate at least once every month for 5 tenures. Moreover, banks are required to follow tighter regulation on the information spread and that it can apply to the base rate also. Under the new MCLR system, the EMI and repo rates can have a stronger relationship as compared to the past.

What is the current repo rate in India?

On 4th June 2021, the RBI announced that the repo rate in India will remain unchanged at 4% and the reverse repo rate at 3.5%. The Marginal Standing Facility rate and the Bank rate stands at 4.25%. All the rates have been decided after considering damages made to the economy due to the second COVID-19 wave.

Any change in repo rate can indeed impact our everyday budget, particularly if we have to pay bank EMI against loans.  This is the reason many loan seekers are advised to study RBI guidelines before investing money in a new asset or for business. While a decline in repo rate can be opportunistic for money borrowers, we must avoid borrowing unnecessary amount when the repo rates are high.

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