Question

The rate at which the Reserve Bank of India lends money to commercial banks is called
1. Prime lending Rate
2. Banker’s Rate
3. Reverse Repo Rate
4. Repo Rate

Answer 1

Correct Answer - Option 4 : Repo Rate

The correct answer is Repo Rate.

• Repo Rate:
  • Repo stands for Repurchase Rate.
  • Repo rate is the rate at which the central bank of a country lends money to commercial banks in the event of any shortfall of funds.
  • In the event of inflation, central banks increase the repo rate as this acts as a disincentive for banks to borrow from it. This ultimately reduces the money supply within the economy and thus helps in arresting inflation.
  • Repo Rate is the most vital rate for the common man. Everything from interest rates on loans to returns on deposits is influenced by this important rate set by the RBI, which is why interest rates on home loans, car loans and other forms of borrowings go up and down supported the direction of Repo Rate change.
  • Similarly, banks adjust bank account, fixed deposit returns supported this benchmark.

Prime lending Rate	Initially, RBI focused on making the benchmark rate transparent. It introduced different ways to calculate the benchmark rates. Earlier, banks had prime lending rate (PLR), then came the base rate and later MCLR or marginal cost of funds-based lending rate.
Bank Rate	Bank Rate refers to the official interest rate at which RBI will provide loans to the banking system which includes commercial/cooperative banks, development banks, etc. Such loans are given out either by direct lending or by rediscounting (buying back) the bills of commercial banks and treasury bills. Thus, the bank rate is also known as the discount rate. The bank rate is used as a signal by the RBI to the commercial banks on RBI’s thinking of what the interest rates should be. When RBI increases the bank rate, the cost of borrowing for banks rises, and this credit volume gets reduced leading to a decline in the supply of money. Thus, an increase in the Bank rate reflects the tightening of RBI monetary policy. A decrease in the Bank rate reflects the loosening of RBI monetary policy.
Reverse Repo Rate	The reverse repo rate is the short-term borrowing ​rate at which RBI borrows money from commercial banks.  An increase in the reverse repo rate will lead to a decrease in inflation as commercial banks tend to deposit their money with RBI to garner a higher rate of interest. This will ultimately decrease the money supply in the economy.