Definition: Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.
Description: In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in arresting inflation.
The central bank takes the contrary position in the event of a fall in inflationary pressures. Repo and reverse repo rates form a part of the liquidity adjustment facility.
What is repo rate and reverse repo rate?
Repo Rate: It is the interest rate at which the central bank of a country lends money to commercial banks. The central bank in India i.e. the Reserve Bank of India (RBI) uses repo rate to regulate liquidity in the economy. In banking, repo rate is related to ‘repurchase option’ or ‘repurchase agreement’.When there is a shortage of funds, commercial banks borrow money from the central bank which is repaid according to the repo rate applicable. The central bank provides these short terms loans against securities such as treasury bills or government bonds. This monetary policy is used by the central bank to control inflation or increase the liquidity of banks. The government increases the repo rate when they need to control prices and restrict borrowings. On the other hand, the repo rate is decreased when there is a need to infuse more money into the market and support economic growth.An increase in repo rate means commercial banks have to pay more interest for the money lent to them and therefore, a change in repo rate eventually affects public borrowings such as home loan, EMIs, etc. From interest charged by commercial banks on loans to the returns from deposits, various financial and investment instruments are indirectly dependent on the repo rate. Reverse Repo Rate: This is the rate the central bank of a country pays its commercial banks to park their excess funds in the central bank. Reverse repo rate is also a monetary policy used by the central bank (which is RBI in India) to regulate the flow of money in the market.When in need, the central bank of a country borrows money from commercial banks and pays them interest as per the reverse repo rate applicable. At a given point in time, the reverse repo rate provided by RBI is generally lower than the repo rate. While repo rate is used to regulate liquidity in the economy, reverse repo rate is used to control cash flow in the market. When there is inflation in the economy, RBI increases the reverse repo rate to encourage commercial banks to make deposits in the central bank and earn returns. This in turn absorbs excessive funds from the market and reduces the money available for the public to borrow.
What is the meaning of repo?
Repo stands for ‘repurchase option’ or ‘repurchase agreement’. It is a form of short term borrowing that allows banks or financial institutions to borrow money from other banks or financial institutions against government securities with an agreement to buy those securities back after a specified time period and at a predetermined price (which is higher than the initial sell price).A repurchase agreement is a secured way of raising short-term capital for banks. The duration of these loans generally varies between one day to a fortnight. In this system, the borrower enters into a repo or repurchase agreement, whereas, for the lender, it’s a reverse repurchase agreement or reverse repo.In India, the Reserve Bank of India or RBI (which is the central bank in the country) lends money to commercial banks with an interest rate which is called repo rate. These loans are sanctioned in exchange for securities to help the banks achieve their financial goals. On the other hand, RBI also has provisions for banks to park their excessive funds for which RBI pays interest, which is determined by reverse repo rate. This interest rate is also applicable when RBI borrows money from commercial banks. RBI uses repo and reverse repo to maintain economic stability in the country. When there is a need for an economic boost, RBI pumps funds into the system by helping commercial banks borrow money from the bank. Using repo, banks raise the necessary capital to increase their lending capacity. This ensures liquidity for the bank and proper cash flow into the market. But, in the case of inflation, RBI uses reverse repo to absorb funds from the market to regulate the lending capabilities of commercial banks.
What is the current repo?
Repo rate is the rate at which commercial banks borrow money from the central bank of a country (which in the case of India is the Reserve Bank of India or RBI) when they are in the need of funds. On the other hand, reverse repo rate is the interest rate paid to commercial banks when they deposit their excess funds in the central bank or when the central bank borrows money from them. As of April 2021, RBI’s repo rate stands at 4% and reverse repo rate at 3.35%. The repo rate was reduced by 40 basis points from 4.4% to 4% and the reverse repo rate was pegged at 3.35% in May 2020. RBI has kept these crucial rates unchanged since the last five sessions to accommodate the current economic situation.RBI keeps revising the repo rate and reverse repo rate periodically according to the state of the economy. Every sector of the economy is affected by changes made to these interest rates. Most banks have an RRLR or repo rate linked lending rate and when the repo rate is revised, banks are directed by RBI to change the interest rate applicable on various loans accordingly. Generally, when the repo rate is reduced, the interest rate charged on home loans, EMIs etc. also reduces, making it easier for customers to avail loans or borrow from banks. This in turn helps in the economic growth of the country. Though changes made to repo rates are meant to affect the interest rate of commercial banks, the actual rates applicable for the customer may vary from bank to bank and is also dependent on various factors including the terms of the loan such as the amount being borrowed, tenure of repayment, etc