Have you ever faced a shortage of funds? If yes, then what is the immediate thing you do? Take a loan? The loan can be taken from parents, friends, relatives or banks. Have you ever thought that alike us even banks face a shortage of funds? What will Banks do in such a case? How will they arrange the money? From where they will get a loan? Any guesses? RESERVE BANK OF INDIA (in case of India) is the answer. Correct, whenever Banks needs funds, they take a loan from RBI, i.e. Central Bank of India (or the respective country). Whenever we take a loan from the bank, they charge us interest at a rate. Similarly, the RBI charges the banks an Interest at a specified rate. This interest charged by RBI to the bank at a specific rate is called Repo Rate (Repurchase Option or Repurchase Agreement).
Now, as we know what is Repo Rate, let us understand how it works and how it affects our daily life.
How Does Repo Rate Work?
Whenever Bank requires a loan, they pledge some securities like Treasury Bills at the defined Repo rate to RBI in order to acquire the required loan. So RBI gets these securities issued by the banks and hence banks receive the cash (loan) from RBI.
How Repo Rate Affects Our Daily Life?
Whenever Repo Rate increases, banks will get the loans from RBI at a higher rate, thus resulting in banks taking fewer amounts from the RBI. This means borrowing is now costly for the banks. Hence banks will now increase their lending interest rates for the corporates and common people like us. Now, corporates and common people like us will use the money judiciously as the loan from the banks is expensive.
Repo rate and our Bank Loan interest rates are directly proportional to each other. If REPO Rate increases, our Banks’ lending interest rates also increases. Similarly, when Repo Rate decreases, banks’ loan lending rates also decrease thereby reducing the EMI load, hence benefiting common people like us.
How Inflation Is Controlled Through Repo Rate?
Whenever there is inflation in the economy, it means people have more cash available to spend. Hence the cost of goods increases, which leads to inflation. So in such a case, RBI (or Central Bank of any country) will increase the Repo Rate, which means borrowing the loans will now be costly for the bank. As explained above, banks will now increase the rate of interest at which they grant the loan to retail customers like us. Taking a loan from the banks is now expensive, hence there will not be much cash in the hands of customers, which in turn will reduce the supply of cash in the markets, thus controlling the inflation in an economy.
On 27th March 2020, Reserve Bank of India has reduced the Repo rate by 75 basis points and now it stands at 4.4% in light of COVID- 19. This will reduce the burden of EMI (Equated Monthly Installment) as this Rate cut will indirectly lead to a decrease in the loan lending interest rate.
I hope we will recover from this pandemic as early as possible. Let’s expect that RBI will be able to save the Indian economy, with all the precautionary steps taken.
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