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Originally Published on 05.03.2015 ​
WHAT IS ​REPO RATE ?Â
 Editor's Note dated 05.05.2022 : RBI has enhanced its repo rate by 0.40 % to 4.40 %  yesterday  which will have consequences on   Banks, stock markets , inflation , growth and commodity prices  . You  can have a general view of the effects of the move by  RBI by reading the article below.Â
WHAT IS REPO RATE AND REVERSE REPO RATE ?
The rate at which the Reserve Bank of India lends money to commercial banks in the event of shortfall of funds   is known as Repo rate  .  Reverse  Repo Rate is the rate at which  RBI borrows money from commercial  banks . Â
 . Reserve Bank of India as  a banker to bankers  would extend  this facility  to provide funds to the banks in case  of  short of liquidity in the market and   borrow the funds in case of surplus liquid funds with the banks .  Increase / decrease of the rates by RBI  has implications to the commercial banks as their borrowing cost goes up or otherwise . In turn as banks generally pass on  such  costs to the customers ,   ultimate cost of borrowing  from the banks  to the general public will be affected .  But banks need not automatically  change the rates in case of change of Repo rates . ​
Reserve Bank of India  is concerned about the money supply  and its effect on  inflation .  Hence RBI in its effort to control inflation  tries to control the rate at which  funds available to the banks  Hence it increases or decreases its repo rates  to reduce or increase the  availability of funds  to the  market .  Inflation going  up  means  that there is more money supply to the availability of goods / services  and hence  going up of prices of commodities .  Reduction of implies  reduction of  money available to the market  for purchase of commodities .Â
 Earlier the governor of RBI was deciding  on the REPO Rates . Now with signing of  a memorandum  with Central Government ,  RBI has  agreed  to target inflation  with in an accepted band  .  Hence  it has taken responsibility to take action to keep inflation within  a desired band  of 2 % to  6% . ​Monetary policy committee of reserve Bank of India  tweaks Repo rates during their bimonthly meetings ​ Monetary policy Committee of RBI
The Monetary Policy Committee of Reserve Bank of India is responsible for fixing Repo and other benchmark interest rates in India. The meetings of the Monetary Policy Committee ( MPC ) are held at least 4 times a year (specifically, at least once BIMONTHLY) and it publishes its decisions after each such meeting.
The committee  has six members - three  members from the Reserve Bank of India and three external members nominated by the Government of India. The members are  to  keep the deliberations secret atleast for a "silent period" seven days before and after the rate decision for "utmost confidentiality". The Governor of Reserve Bank of India is the chairperson of the committee. Decisions are taken by majority with the Governor having the casting vote in case of a tie. The current mandate of the committee is to maintain 4% annual inflation with an upper tolerance of 6% and a lower tolerance of 2%.[ IMPLICATION OF REPO RATE CUT / HIKE
1. Banks   will reduce  their interest rates  as they have access to  a cheaper fund from RBI ,if Repo Rate is cut .  Interest rates  at which banks lend will  go up  , if Repo Rate is hiked . Hence borrowers  of banks will be benefited with lesser interest burden / increased  interest burden . In case  of Repo rate lowering , Corporates. traders  who have borrowed will have  lesser interest burden and hence  their profitability will improve .Â
2.  As loans from banks will become cheaper or costlier as  per Repo rate movement ,  borrowing from  banks will become attractive or   expensive especially for housing loans and vehicle loans . 3. As banks reduce or increase interest , existing borrowers  will pay less or more EMI in case of housing loan and vehicle loans . It will be beneficial  for middle class borrowers or adverse in case of hike . Some loans may be directly linked to prevailing Repo rate and hence may automatically change according to Repo movement . 4. As bankers need to pay lesser or higher interest on their borrowing ,  profitability will improve or otherwise.  Stock prices  can go up  or come down in anticipation of higher / lower profit . 6. As  interest burden of corporates will come down or go up ,  profits can go up or come down . Hence  in anticipation , their  stock  prices go up or come down . 7. Interest rates on deposits can come down or goes up  as Repo rate movement .  and it will have adverse or beneficial  effect on  those who are dependent up on such  income . Especially retirees depending up on interest income will be affected . 8  As inflation depends up on various factors like  vagaries of weather , international supply  or demand  , government policies  , change in Repo rate done in isolation may have very little effect on commodity prices  . Hence change in Repo rate may not have any desired effect .   9.  REPO RATE LINKED  INSTRUMENTS :  Interest rates  on some deposits and loans are  directly linked  to the prevailing Repo rates and  hence automatically move according to the movement of Repo rates  . Some such instruments are Repo Rate linked Lending rates ( RRLL )  : ​​ Many borrowers would have taken car loans / home loans  with  RRLL interest rates . Hence hike in repo  will automatically move up borrowing cost .   You can check whether your loans are directly linked to Repo rates or not by going through the loan agreement . Repo Rate linked Deposits rates : Some banks have linked their  deposit rates directly to prevailing Repo Rates . For example , SBI has linked Savings Bank interest rates to Repo Rate . 10 .  With increase in deposit rates , savings will be promoted  while borrowings will be reduced  to avoid interest burden . Thus less money will be available in the market  and liquidity will be affected . With tighter money conditions  , demand  will be affected   and  It is expected  to have adverse effect on the liquidity of the system .Â
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