Repo rate, or repurchase rate, is the rate at which RBI lends to banks for short periods. This is done by RBI buying government bonds from banks with an agreement to sell them back at a fixed rate. If the RBI wants to make it more expensive for banks to borrow money, it increases the repo rate. Similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.
Please note that Bank Rate and Repo Rate seem to be similar terms because in both of them RBI lends to the banks. However,
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Repo Rate is a short-term measure and it refers to short-term loans and used for controlling the amount of money in the market, Bank Rate is a long-term measure and is governed by the long-term monetary policies of the RBI. In broader term, bank rate is the rate of interest which a central bank charges on the loans and advances that it extends to commercial banks and other financial intermediaries. RBI uses this tool to control the money supply.
How Repo Rate Works?
When RBI reduces the Repo Rate, the banks can borrow more at a lower cost. This contributes to lowering of the rates.
The following graph shows the variation of the Repo Rate in the longer duration.
The above graph shows that Repo rate has been repeatedly increased and decreased for last 10 years. It was maximum at 16 % in August 2000 and came down at a minimum level of 4.75% in the April 2009.
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During the Global Financial crisis, RBI has decreased gradually the Repo rate from 9% to 4.75%. This was a mean to inject liquidity in the system.
Once there are signs of recovery, the RBI increases the rates and moves towards a tight monetary policy.