What is Repo Rate & Reverse Repo Rate? Meaning, Difference & More
The Reserve Bank of India publishes and administers monetary policies to control the supply of money in the economy. Its primary objective is stimulating economic development through price stability, financial market efficiency, and more. One way it does this is via repo rate and reverse repo rate — monetary policy tools that can help control the money supply in the economy.
Repo Rate and Reverse Repo Rate
What is Repo Rate?
Repo stands for repurchase agreement, which refers to an agreement between two parties where the seller sells some securities for cash and agrees to repurchase them at a later date at a specified price. When a country’s financial crunch comes up, the central bank of a country (RBI in the case of India) does not hesitate to lend money to commercial banks for a short period of time. In return for this loan, the central bank charges interest on the amount that is lent. This rate of interest is known as the repo rate.
How Does Repo Rate Work?
When consumers borrow money from the bank, they charge interest on the loan amount. This is called the cost of credit. So, when banks borrow money from the RBI during a cash shortfall situation, they also pay interest to the Central Bank on the amount borrowed. The rate at which they borrow money from the Central Bank is called the Repo Rate.
What is Reverse Repo Rate?
Reverse pepo is a useful way for RBI to take in extra money from banks when there is too much cash available in the market. By borrowing money from banks at a reverse repo rate, RBI can help to address the issue of excess liquidity. Banks also benefit from this arrangement as they receive interest on the money they have deposited with RBI.
Similarities Between Repo Rate and Reverse Repo Rate
- The Reserve Bank of India (RBI) provides banks with RR (repo rate) loans, while banks provide the RBI with reverse repo rate loans.
- Both banks and the RBI demand security or collateral in order to avail of loans. Banks issue securities to the RBI in order to avail of loans with repo rates, while the RBI offers securities in exchange for loans with reverse repo rates.
- Both RBI and the banks play a significant role in controlling Inflation.
- Repo rate is a key factor in determining reverse repo rate. RBI’s income represents the spread between the two, and hence the reverse repo rate is always lower than the repo rate.
Repo Rate vs Reverse Repo Rate – What is the Difference?
|Repo Rate||Reverse Repo Rate|
|RBI lends money to banks at repo rate||RBI borrows money from banks at the reverse repo rate|
|Used for controlling inflation and cash deficiency||Used for managing cash flow|
|Involves selling of securities which are later repurchased||Involves transferring of money from one account to another|
|Higher than reverse repo rate||Lower than the repo rate|
Importance of Repo Rate and Reverse Repo Rate
- When the repo rate and reverse repo rate are changed, it impacts the bank lending rates.
- The most effective and efficient methods used by the Reserve Bank of India to maintain price stability and encourage economic growth are repo rates and reverse repo rate.
- Repo and reverse repo agreements are great for banks because they help manage liquidity requirements easily and safely.
Does Repo Rate Affect the Economy?
- High Repo Rate and Reverse Repo Rate: When the repo rate is high, banks borrow less money from the central bank because the cost of borrowing is high. When the reverse repo rate is also high, the banks tend to keep more of their money with the RBI because they can earn higher returns.
- Low Repo Rate and Reverse Repo Rate: When the repo rate is low, banks borrow more money from the central bank because the cost of borrowing is low. When the reverse repo rate is also low, banks park less money into the central bank, as it generates low returns.
What are the Parameters of a Repo Transaction?
The RBI agrees to execute the repo transaction with the banks based on the following factors:
- Hedging & Leveraging: The RBI buys bonds and securities from the banks and provides cash to them in exchange for the collateral deposited.
- Controlling the Economy: The Central bank aims at maintaining the economy and keeping inflation within the limit by increasing and decreasing the repo rate accordingly.
- Short-Term Borrowing: The RBI lends money to the banks for a short period of time. Later, the banks buy back their deposited securities at a pre-decided price.
- Cash Reserve/Liquidity: As a precautionary measure, banks borrow money from the RBI to maintain liquidity or cash reserve.
Collaterals & Securities: The RBI accepts collateral in the form of bonds, gold, etc.
What is the repo rate and reverse repo rate in India currently?
The current repo rate in India sits at 5.40% as per the 5th August 2022 update, and the reverse repo rate sits unchanged at 3.35%.
Who decides the value of the reverse repo rate?
The Monetary Policy Committee (MPC) holds a meeting that is presided over by the RBI Governor to decide the current repo rate or the reverse repo rate for the following term.
What is the bank rate?
Bank rate refers to the interest rate the central bank charges on loans to commercial banks and other financial institutions.
What effect does repo rate have on the life of a common man?
Banks tend to increase the interest rates on their loans when the repo rate goes up. This directly affects the common person because the loans become expensive, and it becomes challenging for people to borrow money for their personal needs. On the other hand, if the repo rate goes down, the loan interest rates also go down.
What is the relationship between Inflation and the repo rate?
The Reserve Bank of India will increase the repo rate if inflation is above what it deems healthy and will reduce it to help stabilize the economy.
What does the repo rate mean for depositors?
Due to a large influx of deposits and lower loan offtake, many banks and NBFCs have been in a position where they have excess funds.
What does the repo rate mean for borrowers?
As a result of a 25-75 basis point increase in the cost of lending by banks, EMIs on home loans are expected to rise by 15 to 50 per lakh of the loan volume. This is true for all other types of loan holders, whether they are taking out a personal loan, a car loan, or a real estate loan.