Repo Rate and Reverse Repo Rate

0
754

Reserve Bank of India formulates and administers monetary policies specifically for the purpose of controlling the supply of money in the economy to stimulate various aspects of economic growth. The primary objective of such monetary policies are promoting economic development through price stability, regulation of the volume of bank credits, improving efficiency of the financial system, promoting investments and increasing diversification in financial markets. In this context, repo rate and reverse repo rate are instruments of RBI’s monetary policy that can help control the money supply in the economy.

Repo Rate: The term ‘Repo’ stands for ‘Repurchase agreement’. Repo is a form of short-term, collateral-backed borrowing instrument and the interest rate charged for such borrowings is termed as repo rate. 

In India, repo rate is the rate at which Reserve Bank of India lends money to commercial banks in India if they face a scarcity of funds. Commercial banks sell government securities and bonds to Reserve Bank of India with an agreement to repurchase the securities and bonds from Reserve Bank of India on a future date at a pre-determined price including interest charges. India’s Repo Rate data was reported at 4.400 % pa in Mar 2020. This records a decrease from the previous number of 5.150 % pa in February 2020.

Reverse Repo Rate: Reverse repo as the name suggests is an opposite contract to the Repo Rate. Reverse Repo rate is the rate at which the Reserve Bank of India borrows funds from the commercial banks in the country. In other words, it is the rate at which commercial banks in India park their excess money with Reserve Bank of India usually for a short-term. India’s Reverse Repo Rate data was reported at 4.000 % pa in Mar 2020. This stayed constant from the previous number of 4.000 % pa for Mar 2020.

 

Following are the key differences between Repo Rate and Reverse Repo Rate

  1. In Repo Rate the lender is the RBI while the borrower is commercial bank, However in case of Reverse Repo Rate the lender in the commercial bank while the borrower is RBI.
  2. Using the Repo Rate the commercial banks get funds from the RBI using the government bonds as collateral while commercial banks deposit their excess funds with RBI and receive the interest from the deposit as per the reverse repo rate.
  3. As the Repo rate increases cost of funds increases for the commercial banks hence loans become more expensive while as reverse repo rate increases money supply in the economy decreases as commercial bank park more surplus funds with RBI.

Repo transactions inject liquidity into the Indian banking system. On the other hand, reverse repo absorbs liquidity from the Indian banking system.

Why is Reverse Repo Rate lower than Repo Rate?

Repo Rate is the rate at which RBI is giving funds to the commercial banks (cost of borrowing) while reverse rate is the rate of interest than commercial banks receive for parking their funds with the RBI (rate of interest). The cost of lending funds is higher than the interest rate, thus repo rate is always higher than the reverse repo rate.

LEAVE A REPLY

Please enter your comment!
Please enter your name here