What is Reverse Repo Rate?

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  • 19 Sep 2023
What is Reverse Repo Rate?

The reverse repo happens when the central bank (RBI) borrows money from commercial banks. In times of need, it gives the central bank a ready source of liquidity. The RBI offers great interest rates for commercial banks to supply money. Check out the article to learn more about the Reverse Repo Rate in India.

The Repo Rate refers to interest rates at which the Reserve Bank of India lends money to commercial banks. And in return commercial banks offer securities to the central bank of the country.

The full form of Repo Rate is "Repurchase Agreement" or "Repurchasing Option." Banks can borrow funds from the RBI by selling eligible securities. The RBI and commercial banks agree to repurchase these securities at a predetermined price. Banks typically use this practice when they are short on funds or need to ensure liquidity during uncertain market conditions. The RBI utilizes the repo rate as a tool to control inflation.

The reverse repo is the opposite of the repo rate. It's the interest rate at which the RBI borrows money from commercial banks in the country. With the reverse rate in India, commercial banks deposit their extra funds with the Reserve Bank of India, usually for a short period.

When the reverse repo goes up, it enables commercial banks to place their extra funds with the RBI for a short period and earn interest on them, making it a safe investment. Due to this, banks have less money available, which reduces liquidity. The RBI takes in the surplus funds from banks and, in return, offers government securities as collateral.

The Current repo rate is at 6.50% and the reverse repo rate is at 3.35%

A higher Reserve repo rate impacts the economy. In such situations, commercial banks prefer to deposit the money in the RBI rather than lend it to individuals. This allows them to earn a high interest rate. Additionally, this will increase the rupee's value.

Moreover, the reverse repo rate in India is used to control inflation. They are increased when inflation is on the rise and decreased when inflation is falling.

The reverse rate will affect home loans because banks will be encouraged to invest their surplus funds rather than lend to individuals. Therefore, increasing reverse rates will increase home loan costs, while lowering them will do the opposite

After looking at reverse repo rate meaning and impact, let's understand how it differs from repo rate:

Repo Rate Reverse Repo Rate
A commercial bank is a borrower, and the Reserve Bank of India is a lender.Commercial banks are the lenders, and the Reserve Bank of India is the borrower.
Repo rates are used to manage short deficiency of funds.The goal is to reduce the overall flow of money in the economy.
Repo rates have a higher interest rate.Compared to the repo rate, the rate of interest is lower.
An interest charge is applied to the repo rate through a repurchase agreement.In a reverse repurchase agreement, interest is charged.
Commercial banks get funds from the RBI.Commercial banks deposit excess funds with RBI and earn interest on the funds.
Increasing the repo rate increases the cost of funds for commercial banks; therefore, loans become more expensive.As commercial banks park excess funds with the Reserve Bank of India when the rate is high. There is a decrease in the money supply in the economy.

Conclusion

To manage the flow of money in the economy, the Reserve Bank of India uses the repo Rate and reverse repo Rate. While the Repo Rate is the interest rate at which RBI lends money to commercial banks, the Reverse Repo Rate is the rate at which RBI borrows money from these banks. The difference between them lies in who is lending and who is borrowing.

The impact of the Reverse Repo on the economy is significant. When it's high, commercial banks prefer to deposit their surplus funds with RBI, reducing the overall money supply. You can learn more about finance and investment opportunities from Kotak Securities, a leading financial institution.

FAQs On Reverse Repo Rate

Repo reverse rate refers to the rate at which the central bank of a country (Reserve Bank of India) borrows money from commercial banks within the country. The objective of this instrument is to control the amount of money in circulation.

RBI uses Reverse Repo to manage money flow.

A repo rate is the rate at which the central bank lends money to commercial banks in exchange for securities, while a reverse repo is the rate at which it borrows money from commercial banks.

RBI's Monetary Policy Committee (MPC) determines reverse repo rates.

With the reverse repo rate increasing, commercial banks can put their additional funds into the safe custody of the Reserve Bank for a short period and earn attractive interest rates. It reduces the banks' liquidity.

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