Repo rate is an important concept in the world of banking and finance. It is the rate at which the Reserve Bank of India (RBI) lends money to commercial banks. The fact that it is a crucial tool of monetary policy in India cannot be undermined. The RBI typically uses this rate to regulate the liquidity in the banking system and affect the interest rates in the economy, and thereby control inflation. In this article, we will delve further into the concept of repo rate, its implications and significance in the Indian context.
What is Repo Rate?
Repo rate is the rate at which the Reserve Bank of India (RBI) lends money to commercial banks against securities, thereby effectively giving a short-term loan to the banks. In this context, securities refer to bonds, treasury bills, and other government securities. Repo is an abbreviation for Repurchase Agreement. The borrower of funds is required to repurchase the securities at a predetermined rate within a specific period of time.
The repo rate is considered a vital tool of monetary policy in India that enables the central bank to regulate the liquidity in the banking system and control inflation. The repo rate is a determinant factor for setting the interest rates for the wider economy. It is also the rate that is most closely watched by investors, traders, and financial analysts to gauge the monetary policy stance of the RBI.
How Does the Repo Rate Work?
The mechanism behind the repo rate is fairly simple. When the RBI reduces the repo rate, it effectively reduces the interest rates that banks have to pay to the RBI on the money that they borrow. The idea behind reducing the repo rate is to encourage banks to borrow more money from the RBI. This, in turn, increases the supply of money in the banking system and reduces the cost of borrowing for banks.
On the other hand, when the RBI increases the repo rate, banks have to pay higher rates of interest to the RBI. This increases the borrowing cost for banks, and they tend to borrow less from the central bank. This, in turn, reduces the money supply in the economy, increases the cost of borrowing for banks, and leads to higher interest rates in the wider economy.
SLR and Repo Rate
Repo rate and Statutory Liquidity Ratio (SLR) are closely related terms in the Indian banking system. SLR rate refers to the percentage of bank deposits that banks are required to maintain as liquid assets such as government securities, cash, and gold. The SLR is set by the RBI and is periodically reviewed and revised.
A high SLR requirement indicates that banks have to maintain a large amount of liquid assets, which can reduce their ability to lend money and vice versa. The SLR, therefore, has a direct impact on the repo rate. When the SLR is high, banks may borrow more from the RBI through the repo mechanism to meet their liquidity requirements. As a result, an increase in SLR may lead to higher demand for funds in the financial market leading to an increase in the repo rate.
Implications of Repo Rate on Home Loans
Repo rate has a direct impact on the interest rates that banks charge for loans given to retail customers, including home loans. When the RBI increases the repo rate, banks have to pay higher interest rates to the central bank. The banks then pass on this increased cost of borrowing to the retail customers of the bank through higher lending rates.
Therefore, any changes in the repo rate have a significant impact on the cost of borrowing for home buyers. When the repo rate increases, the home loan interest rates increase thereby increasing the burden on the borrower. On the other hand, a decrease in the repo rate brings down the interest rates for home loans, making it more affordable for borrowers.
Timeline of Repo Rate Hikes
The RBI has hiked the repo rate six times since 2018 due to inflationary pressures. The repo rate was raised from 6 percent to 6.25 percent in June 2018, and again to 6.50 percent in August 2018, making it the first rate hike in four years. In its October 2018 policy review, the RBI had kept the repo rate unchanged and postponed the policy announcement to December. By December 2018, the RBI had raised the repo rate to 6.75 percent.
In June 2019, the RBI governor announced another rate hike of 25 basis points (bps), taking the repo rate to 6.25 percent from the previous 6 percent. On October 4, 2019, the RBI announced its fifth straight repo rate cut but kept the policy stance neutral. The central bank cut the repo rate by 25bps to 5.15 percent, the lowest since March 2010. On June 4, 2021, the RBI hiked the repo rate by 25 basis points, taking the key lending rate to 4.0 percent. The RBI cited rising inflation as the reason for the hike.
Conclusion
The repo rate is a vital tool for monetary policy in India. It helps the central bank to regulate the liquidity in the banking system, affect the interest rates in the wider economy, and control inflation. The implications of the repo rate on retail customers and particularly on the home loan market cannot be overlooked. It is essential to monitor the changes in the repo rate closely so that one can anticipate the likelihood of any changes in interest rates that can impact their borrowing capacity.