Repo Rate and Reverse Repo Rate


Repo Rate

Repo is abbreviated form of the ‘rate of repurchase’.

The repo rate was introduced in December 1992.

The rate of interest the RBI charges from its clients on their short-term borrowing is called the repo rate.

Repo means an instrument for borrowing funds by selling securities with an agreement to repurchase the securities on a mutually agreed future date at an agreed price which includes interest for the funds borrowed.

It simply means Repo Rate is the rate at which RBI lends money to commercial banks against the pledge of government securities whenever the banks are in need of funds to meet their day-to-day obligations.

The securities transacted here can be either government securities or corporate securities or any other securities which the Central bank permits for transaction.

It is a money market instrument.

RBI (Reserve Bank of India) decides Repo rate.

Banks usually use this route for one-day borrowing to fulfill their short-term liquidity crunch.

It has direct impact on the nominal interest rates of the bank’s lending.

Repo rate is an important tool used by the RBI to control the supply of money in the banking system.

 

When RBI increases Repo rate—

[1] If the rate is increased, the banks will find it difficult to borrow from RBI and the cost of fund will increase.

[2] This will result in an increase in interest rate in the system.

[3] Decrease in money supply.

[4] Decrease in consumer spending.

[5] Higher the repo rate higher the cost of short-term money.

 

When RBI decreases Repo rate—

[1] Reduction in repo rate will help banks to get money at a cheaper rate.

[2] Increase in money supply.

[3] Increase in demand of goods.

[4] Lower the repo rate; lower the cost of short-term money.

[5] If the repo rate is decreased then banks can charge lower interest rates on the loans taken by customers.

 

Who can burrow?

[1] Central and state governments

[2] All banks— Commercial, RRB (Regional Rural Banks), Co-operative banks.

[3] Non-Banking Financial Institution (NBFC).

 

Reverse Repo Rate

Repo is abbreviated form of the ‘rate of repurchase’.

The reverse repo rate was introduced in November 1996 as part of Liquidity Adjustment Facility (LAF) by the RBI.

Reverse repo” means an instrument for lending funds by purchasing securities with an agreement to resell the securities on a mutually agreed future date at an agreed price which includes interest for the funds lent.”

In other words reverse repo rate is the rate of interest offered by RBI, when banks deposit their surplus funds with the RBI for short periods.

It is a money market instrument.

RBI (Reserve Bank of India) decides reverse repo rate.

The securities transacted here can be either government securities or corporate securities or any other securities which the Central bank permits for transaction.

It has a direct bearing on the interest rates charged by the banks and the financial institutions on their different forms of loans.

In a reverse repo transaction, banks purchase government securities form RBI and lend money                 to the banking regulator, thus earn interest.

RBI uses Reverse Repo Rate to control liquidity in the system.

In the April 2016 monetary policy statement, it was decided to keep reverse repo rate at 50 basis points (0.5%) below the repo rate.

MSF (Marginal Standing Facility) will be fixed 50 basis points above repo rate and Reverse repo would be fixed 50 basis points below Repo rate.