Repo rate, or repurchase rate, is one of the tools of the Reserve Bank of India (RBI) to regulate the flow of money in the economy. Repo rate is the interest rate at which the central bank lends money to commercial banks when there is a shortage of funds.
The current repo rate stands at 4.40% set up by the Monetary Policy Committee (MPC) of the RBI.
The RBI changes repo rate when there is a drop in inflation, which encourages banks to borrow more funds. The banks, eventually, provide funds to customers, thus, increasing the flow of money in the economy.
When there is a drop in the repo rate by RBI, it is always good news for the commercial banks. But if there is an increase in the rate, it becomes difficult for people to borrow funds from banks.
What is EMI?
When an individual takes a loan from a bank, he or she needs to pay back the amount in monthly instalments, each instalment is called equated monthly instalment (EMI). It comprises the principal and the interest.
While repaying a loan, the EMI is generally high as the bank tries to collect most of the interest in the first half of the tenure. However, the EMI gradually changes depending on the principal amount.
How repo rate affects EMI?
In order to encourage the flow of money in the market, RBI slashes its repo rate, so that banks could lower their interest rates on loans. Thus, with low repo rate, banks decrease interest rates on the offered loans, hereafter, decreasing the EMI as well.
Similarly, when the repo rate is set high by the central bank, loans borrowed by the customers become more expensive as the commercial banks increase the EMI.
However, sometimes, commercial banks don’t abide by the change of repo rates which affects customers. To keep this in check, the RBI introduced the Marginal Cost of Funds based Lending Rate (MCLR) calculation for setting the interest rate on loans. With MCLR, banks need to publish new interest rates every month for at least five tenures.
Banks can also have a margin of 25 basis points for their base rate above the MCLR.
