Comparing Bank Rate and Repo Rate

Comparing Bank Rate and Repo Rate

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We are all aware that the RBI's interest rate policy is linked to the bank and the repo rate. However, at the moment, the repo rate is the one that the central bank frequently uses to influence the interest rate that banks charge. The RBI's interest rate signal was the bank rate, especially in the pre-reform period when the repo was still in its infancy. Repo was only made available in 2000. However, prior to the reforms, the administrative interest rate mechanism existed in which the government set bank interest rates. Since the government sets the interest rate for banks, whatever the bank rate is here will have no effect on their interest rate stance. As a result, the RBI's use of the bank rate as an interest rate weapon was purely ornamental prior to the reform.

What is the Bank Rate? - The RBI rediscounts bank-submitted first-class bills of exchange or commercial bills at the bank rate. When a commercial bank holds a commercial bill, it indicates that the amount specified in the bill will only be received by the bank at a later date. At the same time, the bank approaches the RBI for financial assistance. 28 days before the bill's expiration, the central bank gives the bill a rediscount (gives the money in the bill). In effect, the RBI provided the commercial bank with a loan for 28 days with this money through rediscounting. As a result, the commercial bank is required to pay the RBI a discount rate. This discount rate can be compared to the interest rate the RBI charges for a 28-day loan, for example. Due to India's lack of bill culture, bank rates have never been an effective interest rate anchor. Due to a lack of commercial bills, the bank rate has become a dormant weapon. Later, the RBI maintained a bank rate that was one hundred basis points higher than the repo rate.

What's the repo rate? - When commercial banks take out one-day loans from the RBI to meet their liquidity needs, the repo rate is the interest rate they pay. Now, the important policy rate that serves as the foundation for the interest rates that banks charge is the repo. The primary distinction between the repo rate and the bank rate is that eligible government securities serve as the underlying security in the case of the repo rate. Securities listed by the RBI and held by a bank above the SLR limit are eligible securities. Commercial bills are the underlying securities in the Bank Rate. Second, unlike overnight loans, repo loans only last for one day. The loan term is 28 days with the bank rate, however. Thirdly, repo interest rates are 100 basis points lower than bank rates. When the RBI changes the repo rate, the current system changes the bank rate automatically. The gap between the two is set at one percent or 100 basis points. There is also a qualitative difference between the two, which goes beyond this. The RBI's prime policy rate is the repo rate, which serves as an anchor for interest rates. However, the bank rate is a weapon against dormant interest rates.