Difference B/w Bank Rate and Repo Rate

Difference b/w Bank Rate and Repo Rate :

Bank Rate : Definition : The rate of interest of every Central Bank is known as Bank Rate (also known as Discount Rate). Bank rate is the standard rate at which RBI is prepared to buy or rediscount bills of exchange or other eligible commercial papers from banks or make loans and advances to banks against approved securities. It is the basic cost of rediscounting and refinance facilities provided by RBI.

Purpose/Need : When the cash reserves of the commercial banks tend to fall below the legal minimum, the banks may obtain additional cash from the central bank either by rediscounting bills with the central bank or by borrowing from it against eligible securities.

Objective/Impact : Credit Control : Bank rate is therefore used by RBI to vary the cost and the availability of refinance and to change the loanable funds/ lendable resources of banks and other financial institutions. Change in bank rate affects the interest on loans and deposits in the banking system across the board in the same direction, if not to the same extent. Cost of credit/refinance is affected by making variation (increasing/decreasing) in the bank rate. Availability of Credit/refinance is restricted by limiting the type and nature of bills eligible for rediscount. A rise in the bank rate makes borrowings from central bank costly. So the Commercial Banks borrow less and in turn lend less and/or raise their lending rates to their customers.  This discourages business activity, thereby there is decrease in demand for goods and services and ultimately the fall in the price level. The bank rate is therefore raised to control inflation. In the opposite case, lowering of bank rate offsets deflationary tendencies.  

After deregulation and banking reforms since 1991, RBI has gradually loosened its direct regulation of deposit and lending rates of banks and these are left to banks to decide through their Boards, with only a few exceptions. Hence the effectiveness of Bank Rate as a credit control measure is very limited now in India as banks are now free to decide their deposit and lending rates. However, RBI can still affect interest rates via changes in its Bank Rate, whenever the situation of the economy warrants it.

Repo Transaction : Repo means repurchase option/agreement (aka Ready Forward Deal). Repo is a money market mechanism which enables collateralized short term borrowing and lending through sale/purchase operations in approved debt instruments/securities.

Repo Rate & Reverse Repo Rate : It is the annualized interest rate for the funds lent by the buyer of securities to the seller of the securities (borrower). Generally, the repo rate is lower than that offered on unsecured or clean interbank loan for the reason that it is a collateralized transaction and the creditworthiness of the issuer of the underlying securities is often higher than the seller/ borrower. Other factors that affect the repo rate include the creditworthiness of the borrower, liquidity of the collateral and comparable rates of other money market instruments.