Meaning of repo rate and reverse repo rateWhen 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.
Definition of repo rate and reverse repo rateRepo Rate refers to the rate at which centeral bank (RBI in case of India) provides loan to other commercial banks like HDFC, SBI etc. against some collateral like government bonds or treasury bills as security.
Reverse Repo rate definition
1. Repo Rate can manipulate the interest rate charged by commercial banksRBI 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.
2. Repo can be used to control Liquidity in marketWhen 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.
3. Repo can be used to control Inflation rateThough 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.
Effects of Reverse Repo Rate
2. Decreasing the Reverse Repo RateDecrease 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.
Current Repo Rate & Reverse Repo rate in IndiaCurrent repo rate in India - 4%
Current reverse repo rate - 3.35%
These rates were last updated on Jun - 07 - 2021, for latest data , you can visit the following link. Current Repo Rate vs Bank Rate in India
Repo Rate and Bank RateBank Rate is the rate of interest charged by RBI on the loans they provide to commercial Banks. In these loans, no repurchase agreement of government Bonds, treasury bills or other securities as collateral are involved.
Some points related to Bank rate:
- Bank Rate is usually higher than repo rate and a major tool of RBI to control the liquidity of money in the market.
- Bank rate is also known as "Discount Rate"
- Current Bank rate in India is 4.25%
Repo Rate vs Bank Rate