Difference Between Repo Rate and Reverse Repo Rate

There are dozens of terms in the financial world every individual must be aware of. Repo rate and reverse repo rate are two significant terms which, when understood, help you understand the economy of the country. Well, both the repo and reverse repo rate are related to central banks and help you learn about the bank systems. These rates are important for the economy of the country to run efficiently and effectively as they influence interest rates, control inflation, and manage liquidity in the market. In this brief guide, let’s define repo rate and reverse repo rate, understand the difference between repo and reverse repo rate. With this, we would understand how they impact the economy of India.

What Is Repo Rate?

The repo rate is the rate at which commercial banks borrow money from the central bank, which is the Reserve Bank of India or RBI). The Central Bank lends the money to help them meet their short-term needs. If explained in other words, the repo rate is the interest rate the RBI charges for the money taken by central banks.

Banks have to provide securities like government bonds, as collateral to the RBI to get the loan amount. This rate is important because it helps control inflation and maintain liquidity in the market. When the repo rate is high, borrowing becomes expensive for banks, which in turn, makes loans costlier for the public.

What is the Reverse Repo Rate?

The reverse repo rate, also called the reverse repurchase rate, is the opposite of the repo rate. It is the rate at which the RBI borrows money from commercial banks. This process helps the central bank manage liquidity in the banking system. But why does it happen?

Well, when banks have too much money that they cannot lend out to consumers, they keep this money with the Reserve Bank of India. This way they have a risk-free affair in saving their money and also earn interest at the reverse repo rate. By adjusting this reverse repo rate, the RBI can influence how much money banks keep with them versus how much they lend out.

How Does Repo Rate Work?

The repo rate is a powerful tool used by the central bank to control the economy. Here’s a step-by-step look at how it works:

• The RBI decides the repo rate based on various economic indicators like inflation, growth, and liquidity needs.

• When banks need funds, they approach the RBI and offer government securities as collateral.

• Banks agree to buy back these securities at a predetermined price, which includes the interest based on the repo rate.

• If the central bank increases the repo rate, borrowing becomes costlier for banks. They, in turn, increase interest rates on loans to businesses and consumers. This slows down borrowing and spending, thereby, helping to control inflation.

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Major Differences Between Repo Rate and Reverse Repo Rate

Here are the major differences between repo & reverse repo rates:

Purpose    

The repo rate is used for liquidity in the banking system. Banks borrow from the central bank to meet short-term needs. While reverse repo rate is used to absorb excess liquidity from the banking system.

Direction of Transaction:

With the repo rate, money flows from the central bank to commercial banks. With the reverse repo rate, money flows from commercial banks to the central bank.

Impact on the Economy

A high repo rate means higher borrowing costs, which can reduce inflation but slow down economic growth. A low repo rate does the opposite. On the other hand, a high reverse repo rate encourages banks to deposit more funds with the central bank, reducing the money supply and controlling inflation. A low reverse repo rate encourages lending.

Collateral

In repo rate, banks provide government securities as collateral to the central bank. While in reverse repo rate, the central bank provides its securities as collateral to banks.

Frequency of Use

Repo Rate is frequently used to manage short-term liquidity and control inflation, while reverse repo rate is used as a tool to absorb excess liquidity and manage the money supply.

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Conclusion

So, this is how repo rate & reverse repo rate manage the economy. These rates directly impact the interest rates that consumers and businesses face, thereby, influencing everything from personal loans to corporate financing.

For example – If you are considering taking an Airtel personal loan, the repo rate will affect the interest rate you might pay. When the repo rate is low, personal loans, including those from Airtel, become cheaper.

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FAQs

1. What is the current repo and reverse repo rate in India?

The present repo and reverse repo rate in India are 6.50% and 3.35% respectively. These rates are determined by the Reserve Bank of India (RBI) to manage liquidity and control inflation in the economy.

2. What is the meaning of reverse repo rate and how does it differ from repo rate?

The reverse repo rate is the interest rate at which the RBI borrows funds from commercial banks, while the repo rate is the rate at which RBI lends money to these banks. The difference between repo and reverse repo lies in their functions—repo rate helps control inflation, whereas reverse repo rate manages liquidity by encouraging banks to deposit funds with the RBI.

3. What is BPS or Basis Point?

BPS, short for Basis Points, is a unit of measurement used to express changes in interest rates or financial values. For example, a change in the repo rate & reverse repo rate by 50 BPS means a 0.50% change.

4. Who decides the repo rate and reverse repo rate in India?

The Monetary Policy Committee (MPC) of the RBI determines the repo rate and reverse repo rate. They regularly review these rates to ensure economic stability and control inflation.

5. What is CRR and SLR?

CRR (Cash Reserve Ratio) is the percentage of a bank’s deposits that must be held with the RBI in cash form.
SLR (Statutory Liquidity Ratio) is the percentage of net demand and time liabilities that banks must maintain in liquid assets. Both are crucial in maintaining the stability of the banking system, alongside tools like repo rate and reverse repo rate.

6. How does the repo rate affect fixed deposits (FDs)?

When the repo rate increases, banks typically raise their interest rates on loans and deposits, including FDs. This makes FDs more attractive to investors as they offer higher returns. The current repo rate and reverse repo rate influence these decisions.

7. What happens when the repo rate increases?

When the repo rate is increased, it becomes more expensive for banks to borrow money from the RBI, which often leads to higher interest rates for loans. This directly impacts loan affordability for consumers. The repo rate vs reverse repo rate dynamic helps balance borrowing and liquidity in the market.

8. How does the Reserve Bank of India calculate the repo rate?

The RBI calculates the repo rate based on factors like inflation, market conditions, and economic growth prospects. The present repo rate and reverse repo rate are set through regular reviews by the RBI’s Monetary Policy Committee.

9. State the bank rate and repo rate difference.

We have stated the difference between bank rate repo rate reverse repo rate. The bank rate is the interest rate for long-term loans provided by the central bank to commercial banks without collateral, while the repo rate is the short-term rate at which the central bank lends money to commercial banks with collateral. The repo rate is primarily used to manage short-term liquidity, whereas the bank rate influences long-term lending rates.