What is Repo Rate?
The repo rate refers to the interest rate at which commercial banks borrow money from the Reserve Bank of India (RBI). To access loans from the RBI, banks can sell their eligible securities to the central bank and agree to buy them back at a predetermined price.
This process is called Repurchase Agreement or Repurchasing Option, hence the abbreviation ‘repo’. Banks often utilize this option when they need funds or to ensure adequate liquidity in uncertain market conditions. Additionally, the RBI uses the repo rate to control inflation in the economy.
How Does Repo Rate Work?
As mentioned earlier, the RBI uses the repo rate to control the amount of money circulating in the market. If there is a high inflation rate, the RBI will raise the repo rate to make borrowing more expensive for commercial banks. This will discourage banks from borrowing money, which in turn reduces the money supply in the market and helps to bring down inflation.
In the case of a recession, the repo rate is lowered to encourage borrowing, which increases the money supply and stimulates economic growth. Therefore, the repo rate plays a significant role in regulating the economy and maintaining a stable financial environment.
Current Repo Rate in India
On 8 February 2023, the Monetary Policy Committee (MPC) announced that the repo rate was raised by 25 basis points. This means that the interest rate at which the Reserve Bank of India lends money to commercial banks has increased from 6.25% to 6.50%.
On the other hand, the reverse repo rate, which is the rate at which banks can lend money to the RBI, has remained unchanged at 3.35%. The Bank Rate and the Marginal Standing Facility (MSF) rate have both been increased to 6.75%.
The Standing Deposit Facility Rate, which is the interest rate earned by banks on their deposits with the RBI, remains at 6.25%. These changes indicate a tightening of the monetary policy by the RBI, aimed at controlling inflation and ensuring economic stability in the country.
What is Reverse Repo Rate?
The reverse repo rate is the interest rate at which the RBI borrows money from commercial banks in India. It is the opposite of the repo rate, as it is the rate at which banks can park their excess funds with the RBI for a short period of time.
Banks may have excess funds that they do not need to lend or invest, and they can earn interest by depositing these funds with the RBI at the reverse repo rate.
By increasing the reverse repo rate, the RBI can reduce the amount of money in the market, thereby cooling down inflation. Conversely, lowering the reverse repo rate can encourage banks to lend more, increasing the money supply and stimulating economic growth.
Difference between Repo Rate and Reverse Repo Rate
| Parameters | Repo Rate | Reverse Repo Rate |
| Lender & Borrower | The Reserve Bank of India (RBI) lends to commercial banks | Commercial banks lend to the RBI |
| Operation Mechanism | Commercial banks pledge securities to borrow from the RBI and later buy them back | The RBI pledges securities to borrow from commercial banks or to accept deposits from them |
| Rate of Interest | Higher than the Reverse Repo Rate | Comparatively lower than the Repo Rate |
| ROI Applicable | The Repo Rate applies to the Repurchase Agreement (Repo), where commercial banks repay the loan to the RBI with interest at the Repo Rate to buy back the securities | The Reverse Repo Rate applies to the Reverse Repurchase Agreement (Reverse Repo), where commercial banks withdraw their money from the RBI after receiving interest at the Reverse Repo Rate to buy back the securities |
| Purpose/Objective | To control inflation and manage the shortage of money in the market | To control the excess flow of funds and regulate cash flow in the economy |
| Impact of Increase in Rate | Discourages commercial banks from borrowing, which results in an increase in the cost of loans for customers | Causes a shortage of money supply in the market, as commercial banks deposit their excess funds with the RBI to earn more interest |
| Impact of Decrease in Rate | Encourages commercial banks to borrow, resulting in lower costs of loans for customers | Causes an excess flow of funds in the market, as commercial banks withdraw their deposits from the RBI and lend more in the market |
Author Bio:
Tanvi Kaushik specializes in Content Marketing and works with the Digital Team at KreditBee – India’s fastest personal loan platform where self-employed and salaried professionals can easily avail quick loans online in just a few minutes when in need of emergency funds. Tanvi writes to-the-point articles on personal finance and budgeting which are truly appreciated by her readers. She is committed to making money matters easy to understand even for the layman. Her commitment to her work doesn’t stop her from pursuing her hobbies of hiking, trekking and going on adventurous trips.
