How Repo Rate and Reverse Repo Rate Control Money Flow?


The Reverse Repo Rate is the rate at which the Reserve Bank of India borrows money from banks for the short term. Undoubtedly, it is an essential tool for the RBI to maintain liquidity and prevent inflation in the economy from rising. When the RBI needs money, it can use the Reverse Repo Rate to get it from the banks. Consequently, they are offered attractive interest rates by the RBI in exchange for their cooperation.

To comprehend what is Repo and Reverse Repo, it is important to understand that Reverse Repo refers to the interest rate at which commercial banks borrow funds from RBI for liquidity.  It is one of the most critical tools that the RBI uses to control inflation around the country.

In addition to this, the banks have the opportunity to park their excess funds with the RBI voluntarily. It allows them to earn higher interest on their overflowing funds. The Reverse Repo Rate is decided by a committee headed by the Governor of the RBI, known as the Monetary Policy Committee. 

What is Repo and Reverse Repo rate, and how does it work?

Consumers who borrow money from a bank charge an interest rate based on the amount each bank provides. This interest rate is also known as the credit cost. In the same way, banks also pay interest to the Reserve Bank when borrowing money from the RBI during a cash shortfall. Repo Rates are the rates at which they borrow money from the RBI. The Reserve Bank of India borrows money from the banks when there is excess liquidity in the market. A reverse repo rate is a rate at which the RBI borrows funds from the banks. The banks receive interest in exchange for holdings with RBI.

How much is the Current Repo Rate?

As a result of the COVID-19 epidemic, RBI has decided to keep its Repo Rate at 4% in its first bi-monthly monetary policy for the year 2021. If the Repo Rate remains the same, the loan interest rate will remain. If you have taken a loan from a financial institution, your interest rate and EMI will remain the same.

Difference between Repo Rate and Reverse Repo Rate

 Repo rate

  • RBI lends money to banks at the Repo Rate
  • Used for controlling inflation and cash deficiency
  • Involves selling of securities that are later repurchased
  • Higher than the Reverse Repo Rate
  • RBI borrows money from banks in the Reverse

 Reverse Repo Rate   

  • Used for managing cash flow
  • Involves transferring of money from one account to another
  • RBI borrows money from the bank at a reverse repo rate

How Repo Rate and Reverse Repo Rate Control Inflation and Cash Flow?

  • High Repo Rate and a High Reverse Repo Rate: A high repo rate will result in banks borrowing less money from the RBI since the bank will have to pay more for borrowing. The reverse repo rate is also high when the Reverse Repo Rate is high; this will make the banks keep more of their money with the RBI because they will earn a higher return if they do this.
  • Low Repo Rate and Low Reverse Repo Rate: In times of low Repo Rates, the banks borrow more from the RBI because there is a lower cost. Banks will park less money with the RBI in the case of a low REPO rate, which will generate low returns.

Repo Transaction Parameters

  • Leverage & Hedging – Reserve Bank of India purchases bonds and securities from the banks on their behalf, and in exchange, they provide the banks with cash.
  • Economic regulation: RBI’s main aim is to control the economy and keep inflation within limits by increasing and decreasing the Repo Rate according to the situation.
  • Short-term borrowing: Banks lend money for a short period to the RBI in the form of short-term loans. The banks then determine a pre-decided price to repurchase their deposited securities later in the future.
  • Reserves or Cash Liquidity: Banks borrow money from the RBI to maintain liquidity or cash reserves as a precautionary measure.
  • Collateral and securities: Bonds, gold, etc., are considered collateral by the RBI.
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