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Understanding Repo and Reverse Repo Rates
1. REPO RATE AND REVERSEREPO RATE AND REVERSE
REPO RATEREPO RATE
BY: AHANA MOHAN & SABITA MUNDARI
2. WHAT IS REPO RATE?WHAT IS REPO RATE?
Repo or repurchase option is a means of
short-term borrowing, wherein banks sell
approved government securities to RBI and
get funds in exchange.
In other words, in a repo transaction, RBI
repurchases government securities from
banks, depending on the level of money
supply it decides to maintain in the
country's monetary system.
3. Repo rate is the discount rate at which
banks borrow from RBI. Reduction in repo
rate will help banks to get money at a
cheaper rate, while increase in repo rate will
make bank borrowings from RBI more
expensive.
If RBI wants to make it more expensive for
the banks to borrow money, it increases the
repo rate. Similarly, if it wants to make it
cheaper for banks to borrow money, it
reduces the repo rate.
4. PURPOSE OF REPO RATEPURPOSE OF REPO RATE
Repo rate is an important tool used by the
RBI to control the supply of money in the
banking system. If the rate is increased, the
banks will find it difficult to borrow from
RBI and the cost of fund will increase.
This will result in an increase in interest
rate in the system. By reducing the Repo
rate RBI can reduce the cost of borrowing
and there by the interest rate in the system
5.
6.
7. WHAT IS REVERSE REPOWHAT IS REVERSE REPO
RATE?RATE?
Reverse Repo rate is the rate at which
the RBI borrows money from commercial
banks. Banks are always happy to lend
money to the RBI since their money are in
safe hands with a good interest.
An increase in reverse repo rate can prompt
banks to park more funds with the RBI to
earn higher returns on idle cash. It is also a
tool which can be used by the RBI to drain
excess money out of the banking system.
10. PURPOSE OF REVERSE REPOPURPOSE OF REVERSE REPO
RATERATE
RBI uses Reverse Repo Rate to control
liquidity in the system.
If RBI increases the Reverse Repo rate, it
indicates its readiness to accept money at
a higher rate.
Cash rich banks will use this facility to
park their surplus money with RBI.
11. What way a common man isWhat way a common man is
affected by these rates?affected by these rates?
The banks will decide the interest rates
based on their cost of funds. Repo Rate will
affect the rate of interest charged by banks
on various loans like Home Loan, Personal
Loan, car loan etc. As customers of various
loans, all of us will be affected by these
rates indirectly.
12. What way Repo rate and ReverseWhat way Repo rate and Reverse
Repo Rate is Connected?Repo Rate is Connected?
As per the current practice, the Reverse
Repo Rate is maintained at 100 basis points
lower than the Repo Rate. It simply means,
if any bank want to borrow from RBI, it
will pay 100 basis point more than what it
will get, while parking their money with
RBI.
13. Why Repo Rate is always higherWhy Repo Rate is always higher
than Reverse Repo Rate?than Reverse Repo Rate?
Repo rate is always higher than Reverse Repo
Rate, otherwise it will give an opportunity of
arbitrage.
Example: Here we are assuming that Reverse
Repo Rate(8%) is higher than Repo
Rate(7%).Suppose ABF Bank has Rs. 100 in
system, it will park all the money with RBI and
will borrow the same amount from RBI at a
lower interest rate. So the bank will earn an
extra 1% of interest without any risk, which we
call as arbitrage.
14. Who decides the Repo Rate andWho decides the Repo Rate and
Reverse Repo Rate?Reverse Repo Rate?
The Reserve Bank of India (RBI) will be
declaring the above rates, after studying the
needs of the market and the future trends.
These rates are the most important tools in
the hands of RBI to control liquidity of
money in the system.
