Bank rate, repo rate

The bank rate is the rate the central bank pays on reserves.  Reserves are the deposits the banking system (commercial banks) have at the central bank.  This rate thus effectively sets a floor to the interest rate structure-if a bank can earn bank rate on its reserves, why should it lend for less? (Note: this is the bank rate of the Bank of England.  RBI has a different definition.)

The repo rate (and the reverse repo rate) are rates at which the central bank intervenes on the interbank money market to either inject or subtract reserves into and from the banking system.  “Repos are in the form of sale of dated securities by the [central bank] for very short periods with a confirmed buy back provision” RBI Functions and Working.  So the first leg of the repo consists of an absorption of reserves from the banking system.  RBI sells T-bills to the commercial banking system.  Reserves (deposit balances of banks with the central bank) move from banks to the central bank.

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One Response to “Bank rate, repo rate”

  1. Indian Investor Says:

    Hi Sabyasachi,
    As you know The US Fed recently raised the discount rate while leaving the Fed funds rate unchanged. Can you please explain in simple non technical language what exactly these two rates apply to? I searched for information on the web and one view I read is that this is to discourage banks from borrowing directly from the Fed, and to encourage borrowing from private lenders instead; a return to normalcy. Another view I read is that the Fed was compelled to raise this particular rate since the share of Treasury purchases by foreign central banks dropped dramatically in an early Feb 2010 auction. After the discount rate hike, USD rallied against EUR, etc… was further information pointed to in this view.

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