The Repo Rate (short for Repurchase Rate) is the interest rate at which the Reserve Bank of India (RBI) lends money to commercial banks for a short period, usually up to 90 days. It serves as a benchmark interest rate in the economy.
- If the Repo Rate increases, borrowing money from the RBI becomes more expensive for banks.
- If the Repo Rate decreases, borrowing money from the RBI becomes cheaper for banks.
How Does Repo Rate Work?
When banks borrow from the RBI, they need to provide government securities as collateral in a repurchase agreement.
For example:
✔ A bank borrows ₹1 billion from the RBI.
✔ It agrees to repurchase the securities at ₹1.07 billion after the borrowing period.
✔ The ₹70 million difference is the interest paid, which is determined by the Repo Rate.
Impact of Changes in Repo Rate
📌 If RBI Increases Repo Rate:
✔ Bank borrowing becomes expensive → Banks increase loan interest rates.
✔ Loans become costlier for businesses and individuals.
✔ Demand for loans reduces, leading to lower spending and investment.
✔ Inflation is controlled as less money circulates in the economy.
📌 If RBI Decreases Repo Rate:
✔ Bank borrowing becomes cheaper → Banks reduce loan interest rates.
✔ More businesses and individuals take loans, increasing investment.
✔ Consumer spending rises, boosting economic growth.
✔ Deflation risk is reduced, as more money flows into the economy.
Repo Rate and Inflation Control
- When inflation is high, RBI increases the Repo Rate to reduce excessive spending.
- When economic growth slows down, RBI reduces the Repo Rate to encourage borrowing and investment.
Important Note:
- Banks must pledge government securities as collateral.
- These securities cannot come from the Statutory Liquidity Ratio (SLR) quota, as that would reduce the SLR below 19.5% and attract penalties.
- Even when RBI lowers the Repo Rate, banks are not legally required to reduce their own lending rates.
Conclusion: Why Repo Rate Matters
The Repo Rate is a powerful tool used by the RBI to control inflation, regulate economic growth, and stabilize financial markets. It directly affects loan interest rates, investment levels, and overall economic activity in the country.