REPO RATES

Originally Published on 05.03.2015 ​

​REPO RATES

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 .  
 . 
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 tern 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 . 

Now with signing of  a memorandum  with Central Government ,  RBI has  agreed  to taget inflation   with in an accepted band  .  Hence  it has taken responsibilty to take action to keep inflation within  a desired band  of 2 % to  6%  . 

In recent past , RBI has   reduced both Repo Rate & Reverse  Repo  rates  many times  in order to spruce  economic growth . ​

IMPLICATION OF REPO RATE CUT

1. Banks     will reduce  their interest rates  as they have access to  a cheaper fund from RBI . Hence borrowers  of banks will be benefited . Corporates. traders   who have borrowed will have  lesser interest burden and hence  their profitability will improve . 

2.  As loans from banks will become cheaper ,   borrowing from  banks will become attractive especially for housing loans and vehicle loans . 

3. As banks reduce interest , existing borrowers   will pay less EMI in case of housing loan and vehicle loans . It will be beneficial  for middle class borrowers . 

4. As bankers need to pay lesser  interest on their borrowing ,  profitability will improve .  Stock prices  can go up in anticipation of higher profit . 

6. As  interest burden of corporates will come down ,  profits can go up . Hence  in anticipation , their  stock  prices go up . 

7. Interest rates on deposits can come down   and it will have adverse   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 . ​​