What is Repo and Reverse repo rate?
Repo rate is a rate at which Reserve Bank of India lend money to commercial banks when there is a shortage of funds. Monetary authorities use Repo rate to control inflation.To avail these loans from Central Bank, Commercial bank are required to deposit securities like government bonds or treasury bills as collateral.
. Reverse Repo Rate is defined as the rate at which the Reserve Bank of India (RBI) borrows money from banks for the short term. It is an important monetary policy tool employed by the RBI to maintain liquidity and check inflation in the economy.
Difference between ‘Repo rate’ and ‘Reverse Repo rate’
|Basis||Repo rate||Reverse Repo rate|
|Meaning||Repo rate is a rate at which Central Bank lend money to the Commercial Banks against government securities.||Reverse repo rate is a rate at which the Reserve Bank of India borrows money from Commercial banks for the short term.|
|Rate of Interest||Interest rate is higher than Reverse repo rate.||Lower than Repo rate.|
|Purpose||To manage the deficiency of funds.||To decrease overall supply of money in the economy.|
|Mechanism of operations||RBI allows funds to the commercial banks against government bonds as collateral.||Commercial banks deposit their surplus funds with RBI and receive interest on deposits.|
|Control||Inflation||Money supply in economy.|
|Borrower’s objective||To control short term deficiency of funds.||To decrease overall supply of money in economy.|
|Charged on||On Repurchase agreement.||On Reverse Repurchase agreement.|
|Impact of lower rate||Cost of funds decrease for Commercial banks and loan become cheaper for them.||Banks lend more funds and reduce their deposit in Central bank|
|Impact of higher rate||Cost of funds increases for Commercial bank and loan become costly for them.||Money supply in the economy reduces as commercial bank deposit more surplus funds with RBI.|
Impacts of change in ‘Repo rate’:
- Increase in repo rate: With the increase in repo rate, the borrowing from the RBI gets more expensive for commercial banks. As the interest rate on various loans increase, fewer loans are applied for disbursement, restricting the money supply and may negatively affect the country’s economic growth.
- Decrease in Repo rate: A decrease in Repo rate allow commercial bank to borrow funds from RBI at cheaper rate. Thus, banks reduce lending rate to the customers. Reduction in lending rate encourages more borrowers by making credit available at lower rates to thecustomers.
Impact of change in ‘Reverse Repo rate’:
- Increase in reverse Repo rate: with the increase in reverse Repo rate banks prefer to keep more surplus funds with the RBI instead of letting it out in the market. Thus, to cut out excessive liquidity in the banking system, RBI increases the reverse repo rate.
- Decrease in reverse Repo rate: Whenever RBI decides to reduce the reverse repo rate, banks earn less on their money deposited with the RBI. This leads the banks to invest more money in more profitable avenues such as money markets, which increases the overall liquidity available in the economy.