In an unexpected move, recently the Reserve Bank of India has raised the rate at which it lends short term money to banks(Repo Rate). The increase will make borrowing by banks more expensive, is expected to lead to an increase in bank lending rates—from all segments of loan.

RBI has hiked the Repo rate, or the rate at which it lends funds to banks, by 25 basis points to 8%.

It is the first hike in the last 15 months and has came exactly a week after the International fuel prices were raised. The Repo rate hike confirms that inflation is an overarching concern for RBI. For better understanding, this article explains the concept of Repo and its impact on the personal loans.

What is Repo rate?

Repo is the abbreviation of repurchase. To tide over short-term cash crisis, both public sector and private sector banks seek money through the computer screen-based negotiated dealing system (NDS) run by the Reserve Bank of India. For the loan, the banks pay interest rates. This interest rate is called Repo rate. Only primary dealers(financial organisations and non-banking financial organisations) and banks have access to this Repo window. Banks deposit government securities in the form of the loan from the RBI, while in case of reverse Repo, the RBI gives treasury bills(Government securities) and takes cash from the banks. The Repo rate has a direct impact on the interest rate at which banks offer personal loan and other loans to their customers.

Impact of increased Repo on personal loan market

Repo drains money from the banking system by withdrawing the liquidity facility from the subsidiary banks. All banks of the banking system have the NDS screen at the RBI. The Reserve Bank Of India lends money overnight and 3 days on weekends. There is no long-term lending transaction between the apex bank and the subsidiaries. As the Repo rate is increased, now the banks have to pay more to the apex bank. Ultimately, the burden has to be transferred to the customers of personal loans and other loans. In simple words, increased Repo makes the borrowing a costly affair.

Why RBI has hiked the Repo rate?

The RBI has hiked the Repo rate has a tool against inflation. Inflation is at a critical phase due to global increase of oil prices and falling rupee price. As the liquidity situation now comfortable, RBI raised the Repo rate for the first time after March 2007 to give an signal that interest rates are going higher, be it on personal loans or fixed deposits. The RBI also has been persuaded by the fear that inflation may soon touch double-digits and real interest rates, which are nearly negative may hurt the Indian economy.