The Reserve Bank of India’s (RBI) interest rate decisions influence borrowing costs across the economy, affecting everything from home loans and car finance to business credit. Two important terms in this context are the bank rate and the repo rate, which serve different purposes in the central bank’s monetary policy framework.
While the repo rate is the RBI’s primary policy rate, the bank rate has a distinct role in the financial system. Understanding the difference between the two can help borrowers make sense of changes in lending rates, monthly equated monthly instalments (EMIs) and the cost of credit.
What is the difference between the bank rate and repo rate?
The repo rate is the interest rate at which the RBI provides short-term funds to eligible banks against government and other approved securities. The rate is decided by the Monetary Policy Committee (MPC) and serves as the main signal for monetary policy.
The bank rate, meanwhile, is the standard rate at which the RBI is prepared to buy or rediscount eligible bills of exchange and other commercial paper. It is also used to calculate penal interest in cases where banks fall short of their prescribed cash reserve ratio (CRR) or statutory liquidity ratio (SLR) requirements. The bank rate is aligned with the marginal standing facility (MSF) rate.
According to the RBI, the repo rate plays a central role in monetary policy transmission, influencing short-term interest rates and the wider cost of borrowing.
How does the repo rate affect home loans and EMIs?
Changes in the repo rate can influence the interest rates banks charge borrowers. When the RBI cuts the rate, borrowing costs for banks may ease, creating scope for lower lending rates. A repo rate hike can have the opposite effect, making credit more expensive.
The impact on individual borrowers depends on the terms of their loan agreements and the benchmark used to price their loans.
Since October 2019, scheduled commercial banks have been required to link new floating-rate personal and retail loans, including home loans, to an external benchmark. These benchmarks can include the repo rate, Treasury bill yields or other eligible market interest rates. As a result, changes in the repo rate can feed into lending rates on eligible loans, although the timing and extent of the impact depend on the applicable terms and reset arrangements.
For borrowers, a reduction in the applicable interest rate can lower EMIs or shorten the repayment period, depending on how the bank adjusts the loan. An increase can raise repayment costs or extend the time needed to repay the outstanding principal if the EMI remains unchanged.
Borrowers should therefore check whether their loan is linked to the repo rate or another benchmark, along with the applicable spread, reset frequency and repayment conditions.
How does the bank rate work?
Unlike the repo rate, the bank rate is not the primary instrument used by the MPC to signal changes in monetary policy. Its present role is closely linked to the RBI’s lending facilities and regulatory framework.
The bank rate acts as a reference for penal interest charged when banks fail to meet prescribed reserve requirements. The CRR specifies the proportion of a bank’s relevant liabilities that must be maintained as cash reserves with the RBI, while the SLR requires banks to maintain a prescribed share in eligible liquid assets.
The bank rate is aligned with the MSF rate, which allows eligible banks to access overnight funds from the RBI against approved securities under specified conditions
For ordinary borrowers, changes in the bank rate do not necessarily lead to an immediate change in home loan or car loan EMIs. The effect depends on the relevant lending benchmark and the terms of the loan.
Why do the two rates matter?
The repo rate is the main policy signal through which the RBI seeks to influence inflation, liquidity and economic activity. Raising it can moderate borrowing and spending, while lowering it can support credit demand and economic growth.
The bank rate serves a different function within the RBI’s broader framework, including its role in penal interest calculations for banks that fail to meet reserve requirements.
For borrowers, the most important distinction is that a repo rate change can influence floating-rate loan costs, while the bank rate has a more specific regulatory and operational role. Keeping track of RBI policy announcements and understanding the benchmark attached to a loan can help households anticipate possible changes in borrowing costs and plan their finances accordingly.
