We all know that bank rate and repo rate are related with interest rate policy of the RBI. But now, it is the repo rate that the central bank is frequently using to influence the interest rate charged by banks.
Bank rate was the interest rate signal from the RBI especially in the pre- reform period where repo was yet to born. Repo was introduced only in 2000.
But during the pre-reform period, interest rate of banks were fixed by the government and that situation was known as administrative interest rate mechanism. Here, whatever may be the bank rate, it will not influence the interest rate stance of banks since thier interest rate was fixed by government.
Thus in the prereform period, bank rate had only an ornamental value in the RBI’s monetary policy as an interest rate weapon.
What is Bank Rate?
Bank rate is the rate at which RBI rediscounts first class bills of exchange or commercial bills submitted by banks. Here, when a commercial bank holds commercial bill, it means that the amount mentioned in the bill will be coming to the bank only at a later time. At the same time, the bank need money and it approaches the RBI. The central bank rediscounts the bill (gives the money mentioned in the bill) 28 days before the termination of the bill. Effectively, this money given to the commercial bank through rediscounting is a loan provided by the RBI for 28 days. Hence, the RBI charges a rediscount rate from the commercial bank. This rediscount rate can be considered as the interest rate charged by the RBI like in the case of giving a loan for 28 days.
Historically, bank rate never functioned as an efficient interest rate anchor because of lack of bill culture in India. Absence of sufficient commercial bills has made bank rate as a dormant weapon. Later, the RBI has kept bank rate at 100 bps higher than the policy rate (repo).
What is Repo rate?
Repo rate is the interest rate charged by RBI from commercial banks when the banks avail one day loans from the RBI to meet thier liquidity requirements. Now repo is the important policy rate that acts as the anchor for interest rate charged by banks.
Difference between repo rate and bank rate
Difference between bank rate and repo rate is that firstly the underlying security in the case of repo rate is eligible government securities. Eligible securities are securities mentioned by the RBI and held by a bank above the SLR limit. In the case of Bank rate, the underlying securities are commercial bills. Secondly, the tenure of loans under the repo is one day as it is overnight loans. While in the case of bank rate the loan period is 28 days. Thirdly, the interest rate for repo is 100 bps lower than the Bank rate.
Under the present system, the bank rate changes automatically whenever the RBI changes the repo rate. The gap between the two is set at 100 basis points or one percent.
More than this, there is a qualitative difference between the two. Repo rate as an interest rate anchor is the prime policy rate of the RBI. On the other hand, bank rate is a dormant interest rate weapon.