How Does Repo Rate Affect Loan?

The Reserve Bank of India (RBI) has been in the news after it cut the repo rate to 5.50% on 6 June 2025. The repo rate is a crucial tool for regulation of the Indian economy. This rate directly affects the interest rates offered by the commercial banks on loans. In this blog post, we shall understand what a repo rate is, and how it affects loans. 

What is Repo Rate?

The full form of REPO Rate is Repurchasing Option Rate. It is also known as the Repurchasing Agreement. Repo Rate’s definition can be understood as, “the rate, set by the Reserve Bank of India (RBI), at which commercial banks borrow funds from the RBI against the collateral of securities.” RBI uses this tool for the management of liquidity and control inflation in the Indian economy. 

Repo rates are quintessential for the economy’s overall economic stability. When banks borrow funds at the repo-rate from the RBI, they can then lend those funds to clients at an interest rate that is usually impacted by this rate. Banks are encouraged to borrow more when the RBI reduces the repo-rate, which decreases interest rates for customers. On the other hand, banks may raise interest rates on loans, particularly personal loans, to customers as a result of rising borrowing costs brought on by an increase in the repo-rate. 

How Does RBI Calculate Repo Rate?

To calculate the repo-rate, RBI takes into account various factors as well as market conditions. The following points explain how the RBI calculates the repo rate:

• Monitoring Inflation Rate: The Central Bank keeps a close watch on the economy’s inflation rate. Basically, an inflation rate means the rate at which prices of goods and services rise over time. If the Central Bank believes the inflation is high, it may raise the repo-rate to curb spending and decrease demand for controlling inflation. 

• State of Economic Growth: While deciding the repo-rate, the RBI also takes into account the economic growth’s state. The economic growth can slow down as a result of higher repo rates, which make borrowing costlier for businesses as well as individuals. However, if the repo rates are low, they can stimulate economic activity since it makes borrowing more affordable and accessible.

• Liquidity Conditions in Banking System: The RBI evaluates the banking system's liquidity, which refers to the funds available for borrowing and lending. The RBI may decide to raise the repo-rate in order to absorb excess liquidity. On the other hand, in order to encourage banks to borrow and lend more, the RBI may lower the repo rates if there is a lack of liquidity.

• Monetary Policy Committee (MPC): The six-member RBI Monetary Policy Committee meets on a regular basis to determine the repo rates and evaluate the state of the economy. Before reaching a decision, the committee takes into account a number of factors like inflation, growth projections and worldwide economic trends.

How Repo Rates Impact Interest Rate on Loans?

A decrease or increase in the repo rates immediately impacts loans like mortgages, auto loans, business loans, and personal loans. If there is a cut in the repo-rate, it signals the cost of floating-rate loans is expected to decrease. In addition to this, it is anticipated to also lower interest charges for new fixed-rate as well as floating-rate loans. The repo rate’s cut will result in reduced interest payments and borrowing costs for MSMEs. This may ease financial stress and boost business activities. While inflation control remains crucial, reducing borrowing costs can help stimulate demand and support economic growth. This is especially important when inflation is within the RBI’s target range.

When the RBI anticipates that inflation is under control or that growth needs a push, it reduces the rate at which banks borrow money from the central bank. Consequently, the cost of borrowing for banks decreases, which is passed on to consumers through lower interest rates on loans and deposits. This leads to more affordable borrowing, higher consumer spending and greater liquidity in the market, which boosts investment and overall economic activity.

The cost of borrowing from commercial banks falls following a repo rate’s cut. This reduction benefits various types of loans like car, home, education, personal, business, credit cards, and mortgages. With lower borrowing costs, people are more inclined to take loans and spend. This increases the demand for goods and services and helps in revival of growth momentum. Lower repo rates reduce the interest charged on all types of loans, including personal loans, car loans and home loans. This cut is expected to increase loan demand. 

It is important to note that repo rates’ cut typically benefits only those having floating-rate loans. If a loan is under a fixed interest rate, the repo rate’s change will not affect such a loan. Repo-rate reductions, therefore, are especially advantageous for fresh borrowers or those having existing floating-rate loans.

Historical Trend of Repo Rates in India

The table below shows the historical trend of repo rates in India:

As can be seen from the above table, the RBI tends to increase and decrease the repo rates every once in a while. 

Conclusion

Repo rate is the rate at which commercial banks borrow money from the Reserve Bank of India (RBI). The RBI determines this rate by taking into account several factors like state of inflation, economic growth’s pace and liquidity conditions of the banking system. As of 6 June 2025, the repo rate set by RBI is 5.50%. 

Disclaimer: This blog post is for educational purposes only. The information provided here is not to be construed as financial, investment or legal advice. Readers are advised to consult with a qualified financial advisor or banking professional before making any decisions based on repo-rate changes or their impact on loans. The rates mentioned are accurate as of the date of publication and may be subject to change.

Frequently Asked Questions (FAQs)

Q1. How often does RBI change repurchasing optio nrate?

A. Generally, the RBI changes the repo rate four times a year. However, it could be more or less depending on inflation, economic conditions, etc.

Q2. What is the current repurchasing option rate?

A. Currently, the repurchasing option rate is 5.50% (at the time of writing this blog post).

Q3. Which regulatory body decides the repurchasing option rate?

A. The Reserve Bank of India decides the repurchasing option rate in India.

Q4. Why does RBI increase or decrease the repurchasing option rate?

A. The RBI increases or decreases the repurchasing option rate to curb inflation and manage economic growth of India.

Author: Dushyant Sharma

Hey there, I'm Dushyant Sharma. With the extensive knowledge I've gained in past 8 years, I have been creating content on various subjects such as banking, insurance, telecom, and all the important registration and licensing processes for various companies. I'm here to help everyone with my expertise in these areas through my articles.