Repo Rate
Why is the Repo Rate lower when “collateral security is delivered to the lender?”
Also what exactly does this “delivery part mean?”
I mean if you are a borrower and you have collateral security then obviously it should be delivered to the lender “as collateral?”
If you get to keep it yourself it’s not really collateral? Maybe i’m just totally off track here, but nonetheless I fail to understand the logic AND the wording of above phrase
When you get a mortgage on a home, do you deliver your home to the bank?
When a company purchases a manufacturing machine and pledges it as collateral for a loan, do they deliver the machine to the bank?
The reason that the repo rate is lower is that there is less risk to the lender if the lender is in possession of the collateral.
For example, imagine you borrow $10,000 from a bank, and pledge your car as collateral. The car could either sit in your driveway, or you could deliver it to the bank and let them hold it until the loan is paid off. From the bank’s perspective, the loan is less risky if the bank is able to hold the car itself. If they let you hold onto, you could be out joyriding all night every night, which puts the safety of the collateral at risk. If you can’t pay off the loan, and you crash the car, then the bank takes a bigger hit on that loan.
Likewise, if you borrow money from a bank and pledge, say, a Treasury as collateral, the bank would prefer to hold onto the Treasury itself, and would hence offer a lower interest rate on the loan to do so. If you hold the Treasury, there is more risk to the bank that you will not be able to deliver it should you not be able to pay off the loan.
thank you so much!!! yeah makes much more sense now! 