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What is Repo Rate and Reverse Repo Rate

हिंदी में पढ़े

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We can call RBI as the father of all banks as it formulates and administers monetary policies that all Commercial Banks of the country have to follow. It is aimed to provide economic stability and improving the financial systems of India. Repo Rate and Reverse Repo Rate also come under these monetary policies of RBI to regulate money Supply in the country.

Defination of repo rate and reverse repo rate

When people or businesses are in need of money, they seek for loan from the commercial banks. In the same way, when Banks are in an event of short fall of funds, they borrow a short term loan from the central Bank (RBI in case of India) of the country. When people borrow loan, they have to pay an Interest on the loan at a fixed rate of interest, similarly, banks also have to pay the interest rate which is termed as Repo Rate. Technically, repo stands for ‘Repurchasing Option’ or ‘Repurchase Agreement’.

Likewise, when people have some excess money, they give that money to the bank to put in savings account earn some interest on it. Reverse Repo Rate is also like the interest rate earned on deposited money. It is the rate at which Banks park their excess money with Reserve Bank of India usually for a short period of time.

As interest on savings is lower than that of loan, Repo Rate is usually higher than that of Reverse Repo Rate.

Now the question arise that ,How Does Repo Rate Work? When you take loan from the bank, they ask for some collateral or security to grant you the required money as loan. Similarly in this case, an agreement is made in which Banks provide some security such as their treasury bills to RBI to borrow the money and RBI buys these securities at some discounted prices. After some time, banks repurchase these securities from the Reserve bank by paying the debt back. In this way, commercial bank gets money and the central bank gets the security of repayment and the cash flow is maintained.

how does repo rate affect the economy?

Repo Rate can manipulate the interest rate charged by commercial banks

RBI rate cut increases the demand for loans due to lower interest rates.Banks use repo rate to determine deposit rate, lending rates or base rates.Whichever loan you take from the commercial banks, it can be housing loan, car loan etc. is directly affected by the Repo Rate. As the RBI increase repo rate, burden of interest increase on Bank which it try to cover by lending money to people by charging higher rate if interest.
In the same way, if repo rate is reduced by the government, chances are that the loan will be provided at lower rate of interest now.

Repo can be used to control Liquidity in market

When market faces shortage of money flow , then RBI needs to pump funds into the system. For this, it may lower the repo rate. Due to lower repo rate, banks generally reduce the Rate of Interest that it charge on loans given to people. Consequently, businesses and industries find it cheaper to borrow money for different investment purposes to carry out. It also increases the overall supply of money in the economy. This ultimately boosts the growth rate of the economy.

Repo can be used to control Inflation rate

Though Inflation have it’s own perks, but large inflation rate is not desirable . During high levels of inflation, Government and RBI have to take necessary steps, increasing the Repo Rate is one of them. When the Repo Rate is increased, Banks have to pay the high interest to central Bank to cover this expense. Banks then charge higher rate of interest on the loans lended to their customers. As the interest rates increase, it’s obvious that people will generally want to avoid borrowing the loan if possible. This will lead to less liquidity and shortage of money in the market, as there will be less money, demand will also decrease leading to depletion in the Inflation.

how does Reverse repo rate affect the economy?

Increasing the Reverse Repo Rate

Increase in Reverse repo rate means that Bank will get more interest when it will park it’s money in Central Bank. This factor may thus incentivize the banks to place more funds in Rbi reserves which may cause some issues.So what is the problem if Banks do so? If Banks will park more money to RBI, it may result in less number of loans passed which will create shortage of flowing cash in the market and it can contribute to decrease in the liquidity of market money.

Decreasing the Reverse Repo Rate

Decrease in Reverse Repo Rate can be taken as a prevention step from the conditions that may arise due to an increase in it.On it's own, it doesn't have much effect on people. It will only provide less interest to the commercial Banks for it's extra cash.