The interest rate at which the RBI lends money to commercial banks for a short period, against government securities kept as collateral, under its Liquidity Adjustment Facility (LAF), is known as the repo rate. Banks borrow from the RBI when they are short of cash, and this rate is the base cost of that borrowing.
When a borrower asks what is repo rate, the short answer is that it is the policy rate of the RBI. Other interest rates in the economy, such as those on floating rate loans and deposits, take this rate as their starting point.
How the RBI sets and passes it on
The repo rate sits in the middle of a corridor. Banks with surplus cash can park it with the RBI under the standing deposit facility (SDF), at a rate 25 basis points (bps) below the repo rate. Banks needing more money than the repo window gives can borrow under the marginal standing facility (MSF), at a rate the same distance above it.
Banks reset the floating rate loans linked to the repo rate after a change is announced. For an individual repaying a floating rate loan of Rs 50 lakh, there will be a difference of around Rs 12,500 per year in interest if the linked rate moves by 0.25 percentage point, calculated on the full amount without considering repayments.
Why it matters to an investor
A change in the repo rate reaches the monthly instalment amount on loans, the interest offered on deposits, the yields on bonds and the borrowing costs of companies. Investors therefore watch how banks, debt funds and rate sensitive sectors such as real estate and automobiles are affected after every policy decision.
The repo rate is often mixed up with the SDF rate. The repo rate is what banks pay the RBI to borrow money, while the SDF rate is what banks earn when they park surplus cash with the RBI. These are two different rates, kept a fixed gap apart in the corridor, and the MSF rate and the Bank Rate are separate rates again.