RBI hikes repo rate by 50 bps to 4.9%

Due the rate hikes by the central bank, lenders like banks and housing finance companies will increase their lending rates correspondingly, which in turn means that. Now new borrowers and existing floating rate borrowers like home loan borrowers will have to dole out higher EMIs for their loans.

What is Repo Rate?

• ?Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds. The lending here is overnight lending.
• Repurchase Options or Repo, is a money market?instrument, which enables collateralize short term borrowing?and lending through sale/purchase operations in debt instruments. Collateralize here means collateral based or security based or guarantee based.
• This is an instrument used by the RBI and banking institutions to manage their daily / short term liquidity.

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How Repo Rate controls inflation and growth?

• High rate regime:?When the RBI keeps Repo Rate high, banks tend to borrow less money from the central bank due to the high cost of funds.
• Low rate regime:?Conversely, when the RBI keeps Repo Rate low, banks can borrow more money from it at low cost.

High Repo Rate and Reverse Repo Rate leave less money available with banks to lend, and vice versa. Credit, as we know it, is the backbone of a capital-led economy. Less availability of loans due to the high costs of borrowing restricts money supply for furthering economic activity. This comes in handy when the inflation is high by RBI’s target standards, and there is a need to rein in the rise in prices to check overheating in the economy. Often, this comes at the cost of some economic growth.

On the other hand, when the inflation is well under control, and economic growth is cooling off a bit too much, RBI may want to cut Repo Rate and Reverse Repo Rate. This is aimed at increasing credit availability and reducing the cost of borrowing, leaving more money in the hands of entrepreneurs and businesses to fuel economic activity.

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How does Repo rate work?

·????????When?you borrow money from the bank, they charge an interest on the principal. Basically, it is cost of credit. Similarly, banks?too can borrow money from RBI during cash crunch. So they must pay interest on the amount borrowed to the Central Bank.

·????????Thus, if a bank needs money in short span of time, it contacts RBI and asks for overnight lending. RBI lends the bank the required fund at an interest rate called?REPO RATE.

·????????Technically, Repo?stands for?‘Repurchasing Option’. It is a contract in which banks provide eligible securities such as Treasury Bills to the RBI while availing overnight?loans.

·????????An agreement to?buy them back at a predetermined price will also be in place. So,?this interest rate is levied on these kinds of?repo transactions?as well.?