Q.6 Repo rate is the rate at which Reserve Bank of India (RBI) lends commercial banks, and reverse repo rate is the rate at which RBI borrows money from commercial banks. Which of the following statements can be inferred from the above passage?
(A) Decrease in repo rate will increase cost of borrowing and decrease lending by commercial banks.
(B) Increase in repo rate will decrease cost of borrowing and increase lending by commercial banks.
(C) Increase in repo rate will decrease cost of borrowing and decrease lending by commercial banks.
(D) Decrease in repo rate will decrease cost of borrowing and increase lending by commercial banks.
Understanding RBI Repo Rate: MCQ Analysis and Economic Impact
Repo rate, set by the Reserve Bank of India (RBI), directly influences commercial banks’ borrowing costs and their lending behavior in the economy.
Correct Answer
The correct option is (D) Decrease in repo rate will decrease cost of borrowing and increase lending by commercial banks.
This inference aligns with the passage, as a lower repo rate reduces the expense for banks to borrow from RBI, enabling them to offer cheaper loans and extend more credit to customers.
Passage Explanation
The passage defines repo rate as RBI’s lending rate to banks and reverse repo as RBI’s borrowing rate from banks, establishing a direct link between these policy tools and banks’ funding dynamics.
When RBI cuts the repo rate, banks face lower short-term funding costs, prompting them to reduce lending rates and boost credit availability to stimulate economic activity.
Option Analysis
| Option | Statement | Correct/Incorrect | Reasoning |
|---|---|---|---|
| (A) | Decrease in repo rate will increase cost of borrowing and decrease lending by commercial banks. | Incorrect | This reverses the mechanism; lower repo reduces banks’ costs, leading to cheaper loans and more lending. |
| (B) | Increase in repo rate will decrease cost of borrowing and increase lending by commercial banks. | Incorrect | Higher repo raises banks’ borrowing expenses, resulting in costlier loans and reduced lending to curb inflation. |
| (C) | Increase in repo rate will decrease cost of borrowing and decrease lending by commercial banks. | Incorrect | While lending decreases due to higher costs, borrowing costs actually rise for banks, contradicting the statement. |
| (D) | Decrease in repo rate will decrease cost of borrowing and increase lending by commercial banks. | Correct | Matches the passage logic: cheaper RBI funds allow banks to lower rates and lend more freely. |
Key Implications
Changes in repo rate serve as RBI’s primary tool for liquidity management, with cuts promoting growth through easier credit and hikes controlling inflation via tighter conditions.
For borrowers in India, tracking repo decisions helps anticipate shifts in home loan EMIs, business funding, and overall economic sentiment.
