Difference Between Bank Rate and Repo Rate
Bank Rate vs Repo Rate
Repo rate and Bank rate are two commonly used rate for borrowing and lending that are used by the commercial and central banks. These rates are used in financial transactions between a national or central bank and a domestic or commercial bank. Although, both rates are considered the same, yet, there are some prominent differences between the two.
Another name used for bank rate by the financial institutions is a discount rate. The bank rate is used by commercial banks when they borrow money from the central bank, and the reason why they secure a loan is because of the anticipated shortage of funds in these banks.
Every individual must be aware of the fact that a bank rate has a direct impact on the lending rates offered by commercial banks to their clients. The lending rate charged to commercial banks is passed down to the individuals who borrow loan from these banks. If the bank rate decided between a central and commercial bank is high, the rate offered by a commercial bank to its clients will also be higher, and if the rate provided by a central bank is low, the lower rate will be charged by commercial banks on the loan issued to the clients.
Another important fact about bank rates is that these rates are used by central banks of different countries to control and manage the currency supply for the betterment of national economy and their banking sector. When the unemployment rate in a country goes up, the central bank of that country reduces the bank rate so that commercial banks offer decreased rates on loans to the individuals. Note that such lending transactions do not involve any collateral.
Repo rate, on the other hand, is slightly similar to the bank rate. This rate is also known as the repurchasing rate, and this rate is used in a banking transaction like a repurchase agreement. In a repurchase agreement, central bank sells securities to commercial banks and agrees to repurchase these securities after a certain period of time at a pre-defined price. Therefore, the interest rate used in these securities for repurchase is known as a repo or repurchase rate.
Like a bank rate, the repo rate is used to regulate the supply of currency in an economy. If the repo rate is lower, it expands the monetary system, and as a result, financial institutions get funds at low-priced rates. On the contrary, if repurchase rate is higher in the economy, it reduces the currency supply, which eventually causes shortage of borrowing funds, leaving individuals with limited access to take loans.
So, repurchase agreement allow security holders to sell and repurchase the securities in order to raise money. This agreement uses a collateral in the form of securities, and the repo rate usually serves as a profit from selling these securities.
Let’s look at some of the differences between a bank rate and a repo rate.
Loan vs. Securities – As already discussed, bank rate usually deals with loans, whereas, repo or repurchase rate deals with the securities. The bank rate is charged to commercial banks against the loan issued to them by central banks, whereas, the repo rate is charged for repurchasing the securities.
Using a Collateral – No collateral is involved in a bank rate. But a repurchase agreement uses securities as collateral, which are repurchased at a later date.
Which rate is higher? – If you observe the market, you will find that repo rate is comparatively lower than a bank rate.
Effect on Lending Rate and Term Period – Repo rate is usually used to cater the short term fund requirements of businesses. So, when central banks increase the repo rate, they try to reduce liquidity in the economy. However, it doesn’t affect the market rate of interest, because commercial banks bear the additional burden to secure their customer base. But as soon as the bank rate increases, it directly affects the lending rate offered to customers, discouraging them from taking loans and damaging the overall economic growth. Repo rate might leave an impact on the investment amount, but its impact will not be as direct and drastic as a bank rate.
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