- A bank rate is essentially the rate at which the Reserve Bank of India (RBI) lends money to commercial banks without any security or collateral.
- It is also the standard rate at which the RBI will buy or discount bills of exchange and other such commercial instruments.
- As the central bank or the Reserve Bank of India increases the bank rate, the commercial bank would also have to increase their lending rates. Thus, by manipulating benchmark policy rate RBI controls money flow in the market.
How is the Bank rate different from Repo Rate?
- The Bank Rate as well as the Repo Rate is used for the same purpose but some basic differences are there which are:
- Loan vs. Securities: Bank rate usually deals with loans, whereas, repo or repurchase rate deals with the securities. The bank rate is charged to commercial banks against the loan issued to them by central banks, whereas, the repo rate is charged for repurchasing the securities.
- Using a Collateral: No collateral is involved in a bank rate. But a repurchase agreement uses securities as collateral, which are repurchased at a later date.
- The repo rate is comparatively lower than a bank rate. Repo rate is usually used to cater the short term fund requirements of businesses. So, when central banks increase the repo rate, they try to reduce liquidity in the economy.
- However, it doesn’t affect the market rate of interest, because commercial banks bear the additional burden to secure their customer base. But as soon as the bank rate increases, it directly affects the lending rate offered to customers, discouraging them from taking loans and damaging the overall economic growth.
- Repo rate might leave an impact on the investment amount, but its impact will not be as direct and drastic as a bank rate.