Monday, 7 December 2015

Banking Awareness: What is Repo Rate?

What happens when banks run out of money? Do the people stop getting their money? Have you ever come across a situation where the bank told you that it has no funds to provide you with your money? I am sure such a situation has never been faced by you. But banking is a business; banks take your money and give it to people who come to ask for loans, this is the primary business of banks. So what do they do when there is a shortage of money in the banks themselves? They seek help from the central bank, which in the case of India is the reserve bank of India or RBI.

When you hear the term “Rate” the first thing that comes to your mind would be “price”. We often use the term rate in our everyday life but here, the meaning of rate is not price.
Repo rate is basically the rate or the rate of interest at which the central bank of the country for e.g. RBI in case of India, lends money to the commercial banks in case of shortage of funds for short term purposes. It is the rate of interest with maturity period of one day and is also called as the key short term lending rate.

The Central Bank is an institution that is responsible for supply of money in the economy and regulating the interest rates. It acts as a governing body for the commercial bank and is responsible for supervising the functioning of the commercial banks.

The commercial banks are the banks that deal with the money of the general public. They accept deposits from the general public and extend loans. They provide various banking services such as fixed deposits, cheques etc to businesses, institutions and some individuals.  They are accountable to the central banks for their functioning.

Still didn’t understand? Let’s look at an example!

Repo Rate:

Suppose there is a bank named ABC in your country and you have kept an amount of Rs.10 Crores in the bank. You wish to get that amount as you urgently require it. Now suppose the bank has given too many loans this month and it doesn’t have the funads to fulfill your request. In this case, the commercial bank ABC will ask the central bank (RBI for India) to give it the required sum. The rate of interest at which the central bank will give the money to the commercial bank is called as “Repo Rate”.

What happens if the commercial banks deposit their money with the central bank? The answer is pretty much obvious, they receive interest on the money they have kept. This interest rate that the commercial banks receive by keeping their money in the central bank is the reverse Repo Rate. It is always lower than the Repo Rate.

How does Repo Rate control inflation?

In case of inflation which is a sudden rise in prices of commodities due to certain factors, the RBI often increases the repo rate in order to decrease the supply of money in the commodity. If the repo rate is increased, the banks will be induced in not to borrow money from the RBI and the money supply in the economy will reduce. Since money supply is reduced, people will spend less and when people will spend less the demand for the commodities will decrease. With decreased demand for commodities, the prices of the commodities will fall which will at last control inflation. Thus, lowering or increasing of the repo rate and the reverse repo rate is an important factor in controlling inflation. It also has an effect on the interest rate of commercial banks in loans, savings, mortgages and so on.
In order to have a firm grasp over banking awareness you need to know the meaning of the term “Repo Rate” as it is an important topic when it comes to the world of banking awareness.

Also read for IBPS Bank Po and Clerk Exam : Banking Awareness Study Notes:

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