What is Repo Rate?
It is the interest rate at which the Reserve Bank of India (RBI) or Central Bank of India lends money to some commercial banks. If a financial crisis occurs, the commercial banks are in a position to borrow money from the Central Bank of India, and the rate of interest at which the money is given is the repo rate. Central banks use the repo rate to control the supply of money in the market. This helps control inflation and to regulate the economy.
The Function of Repo Rate
You now know what is repo rate is and how central banks use it to control the money flowing in the market. When there is inflation in the market, the Reserve Bank of India increases the repo rate. An increase in the repo rate denotes that banks that take or borrow money at this time from the central bank will need to pay a higher amount as interest. This will discourage the bank from borrowing some money that will, in turn, reduce the money supply in the market and negate inflation. Similarly, during a time of recession, the repo rate decreases.
How does the RBI Calculate the Repo Rate?
Depending on whether there is a recession or inflation, the RBI decides on its repo rate. The Central Bank thus calculates them in this manner.
Factors that affect a Repo Transaction
- Cash Reserve (or) Liquidity
Banks take money from the Reserve Bank to regulate their cash reserve or liquidity as a measure of precaution.
- Collaterals and Security
RBI takes collateral in the form of bonds and gold.
- Short-term borrowing
RBI lends money for a short time period.
- Preventing squeezes in economy
Through the repo rate, the RBI prevents inflation that can cause strain on the economy. It also affects the personal loan EMI repayment.
2022 Repo Rate
In 2022, the RBI has decided not to change the repo and reverse the repo rate. The reverse and the repo rate continue to remain at 3.35% and 4%, respectively.