The repo rate, or repurchase rate, is the primary monetary policy rate at which the Central Bank or Reserve Bank of India (RBI) lends money to banks in the short term and is essentially a measure of credit availability, inflation, and economic growth control. The Indian repo rate is the primary instrument of the RBI’s monetary and credit policy.
Repo rates are also the most significant rate for ordinary people. Everything from loan interest rates to deposit yields is affected by this important interest rate set by the RBI. Consequently, interest rates on mortgages, auto loans, and other types of loans go up and down depending on the direction of change in the repo rate.
Repurchase option agreement
A repurchase option agreement is a forward contract between a commercial bank and a central bank, where the commercial bank agrees to repurchase government bonds at a predetermined rate after the repo period ends.
Repo period
This usually happens overnight. However, the term Repo has been introduced by the Reserve Bank of India, which means the interest will be paid in 7 days or 14 days.
Repo rate by RBI
The Monetary Policy Committee (MPC) has risen the repo rate by 50 basis points in August 2022 and is now at 5.40%. During the meeting, the MPC decided to leave the reverse repo rate at 3.35%. The bank and marginal standing facility (MSF) rates have also changed and are now 5.15%.
Repo Rate changes
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Interest rate
|
Rate (Percent)
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|---|---|
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Repo Rate
|
4.9
|
|
Bank Rate
|
5.15
|
|
Reverse Repo Rate
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3.35
|
|
Marginal Standing Facility Rate
|
5.15
|
What is the reverse repo rate?
In India, the current reverse repo rate is set by the RBI’s Monetary Policy Committee* (MPC), which is headed by the RBI Governor. Decisions are made at bimonthly meetings of the Monetary Policy Committee. The reverse repo rate is at which the RBI borrows money from banks in the short term. It helps RBI to raise funds from banks when needed. In return, the RBI offers them attractive interest rates. Banks also voluntarily reserve surplus funds with central banks because this allows you to earn higher interest rates on your idle surplus funds.
The reverse repo rate is the primary monetary policy tool used by the Reserve Bank of India (RBI) to control economic liquidity and inflation. Commercial banks also retain surplus funds received in RBI as they are considered safe. An additional benefit is that the RBI also pays interest, allowing banks to earn interest on their idle funds.
Reverse repurchase option Agreement
This is a buying and selling agreement between the Bank and its RBI, in which the Bank commits to resell the government securities such as treasury Bonds to the RBI at a pre-determined interest rate after the reverse repo period.
Reverse repo period
Like the repo rate, the reverse repo rate also usually happens overnight, which means the interest will be paid in 7 days or 14 days.
What changes does the repo rate bring to the economy?
If the repo rate is low, banks will receive funds from the RBI at a lower interest rate. This allows banks to lower interest rates and make credit more affordable. Low-interest rates are also not attracting savings. In this way, money is injected into the economy, and economic activity is activated. Therefore, the RBI cuts repo rates whenever it wants to stimulate the economy.
Reverse repo rates, on the contrary, are used during times of high inflation due to excess liquidity in the economy. During this time, the RBI raises the reverse repo rate to allow banks to deposit funds in their RBI to earn higher interest rates. With less money, banks will be unable to lend to consumers. Therefore, the reverse repo rate will be increased to withdraw surplus funds from the market/system.
What changes does the repo rate bring to the strength of the Rupee?
Higher reverse repo rates reduce the money supply in the market as banks entrust surplus funds to the RBI for attractive yields compared to lending to individuals and businesses. It reduces the amount of money in the system, thereby increasing the strength of the Rupee.
How does the reverse repo rate affect home loans?
If the RBI raises the reverse repo rate, banks will be able to raise mortgage lending rates because it’s more profitable to invest in low-risk government-backed securities than to lend people money in the form of mortgages. If reverse repo rates go down, so can mortgage rates.
Main differences between repo rate & reverse repo rate
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Parameters
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Repo rate
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Reverse repo rate
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|---|---|---|
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Controls
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The Repo rate is used to control inflation in the economy
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The reverse repo rate controls the money supply in the economy
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Purpose
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It is used to fulfill the lack of funds
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It is helpful to maintain liquidity in the economy
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Operations
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RBI provides funds to commercial banks against government bonds as collateral
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Commercial banks deposit surplus funds with RBI and receive interest on the deposits
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Borrower’s objective
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A repo rate is used to manage short-term cash shortages.
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Reverse repo rates are used to reduce the money supply of the economy.
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Current rate
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The current repo rate is 5.40%
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The current reverse repo rate is 3.35%
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Charged on
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The repo rate is charged on the repurchase agreement
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It is charged on the reverse repurchase agreement
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Rate
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The repo rate is always higher than the reverse repo rate
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The reverse repo rate is always lower than the repo rate
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Effect of the rate increase
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Higher interest rates will force commercial banks to borrow less from the central bank.
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Encourage commercial banks to send more money to the central bank and earn interest.
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Effect of the rate decrease
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This makes it cheaper for banks to get loans from the RBI.
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This allows banks to make better investments than depositing money in RBI.
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Conclusion
The main difference between repo rate and reverse repo rate is that in the case of repo, in the case of reverse repo, the central bank injects liquidity into the economy by lending to commercial banks at more favorable interest rates. But banks absorb liquidity from the economy by raising interest rates.
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