Difference Between Bank Rate and Repo Rate

Bank Rate vs Repo Rate

There are financial instruments in the hands of apex or central banks of the nations to control money supply and thus, inflation and many other monetary situations in the economy. Bank rate is one such tool that controls the amount of money in the economy and is regularly used by the central banks of all countries. Here it can be argued that when there is a government in place, why such powers have been relegated to central banks? Well, the answer is that populist governments cannot take harsh measures as their popularity goes down, which is why there are economic measures taken on their behalf by central banks such as Federal Reserve in US and RBI in India. There is another rate called repo rate which has similar effect on the economy and confuses common people as they cannot find differences between bank rate and repo rate. This article tries to highlight the features of both these instruments to elucidate their differences.

There are times when commercial banks have shortage of funds, and look up to the central bank of the country to fulfill this shortage. The apex bank charges a rate of interest when extending loans to commercial banks, which is known as bank rate. It is within the jurisdiction of apex bank (reserve bank) to increase or decrease this bank rate. The effect of increasing this rate can be seen on money supply in the economy, which goes down as banks are reluctant to ask for money at a higher bank rate from the reserve bank. On the other hand, when the bank rate is decreased, it makes available funds at low rates of interest to the banks that are extended forward by commercial banks to common people, either industrialists or agriculturists, thus helping in increasing economic activities and thus, GDP of the country.

Repo rate, which is also referred to as repurchase rate is the rate of interest at which banks borrow money from the central bank in India. Often, demand for money from commercial banks grows more than the funds they have in hand, and this is when they need funds from the reserve bank. It is upon the reserve bank, how it perceives the situation in the economy of the country. If it feels that banks should provide loans at a lower rate of interest to common people so as to ward off inflationary measures, it lowers the repo rate thus, prompting banks to borrow more from it and pass on this benefit to the common customers.

It is clear that whether reserve bank increases bank rate or the repo rate, the net result on the economy is that liquidity goes down and inflation is controlled. So, how does the apex bank decide which rate to increase or decrease? Well, the answer to this question lies in the nature of the two rates. Bank rate is always a long term measure, whereas repo rate is short term measure to fulfill the shortage of funds of commercial banks.