What is the repo rate?
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The repo rate is the interest rate at which the RBI or the Reserve Bank of India lets commercial banks borrow money
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Repo Rate and Reverse Repo Rate: Key Differences
By Bajaj Broking Team
December 13, 2024
5 mins read
Must Reads
Both the repo rate and reverse repo rate are interest rates that play a very important role in the country’s economic health. Both these interest rates are essential tools that help central banks monitor liquidity and control inflation which leads to the stabilisation of the economy.
Of these two interest rates, the reverse repo rate, specifically, impacts citizens more, especially if they have taken a loan. With any changes to the reverse repo rate by a central bank, a consumer’s borrowing cost changes. This is why it is important to be aware of these two rates of interest as it helps the common man opt for a more affordable interest rate when they want to take a loan. Here is everything you need to know about these two rates of interest.
What is Repo Rate?
The repo rate is the interest rate at which the RBI or the Reserve Bank of India lets commercial banks borrow money. ‘Repo’ here is a shorter form of "Repurchase Agreement" as it involves a transaction of temporary nature between commerical banks and central banks. In this case, to borrow money from the RBI, financial institutions like commercial banks sell securities to the RBI while signing an agreement to buy these securities back at a later date at a predetermined price.
The current Repo Rate in India, fixed by RBI is 6.50% and remains unchanged |
What is Reverse Repo Rate?
The reverse repo rate applies when the case gets reversed. So, when the RBI needs to borrow funds from commercial banks, it is charged the reverse rate. The system in this case also works the same way, but in reverse. Here, the RBI pays the reverse repo rate to the commercial banks on the funds borrowed by selling them securities. After purchasing securities from commercial banks, the RBI sells them back at a later date and at a specified price.
The current Reverse Repo Rate in India, fixed by RBI, is 3.35% and remains unchanged |
Calculation of Repo Rate by the Reserve Bank of India
The main reason behind the need for extra funds by commercial banks is the deficiency of assets. With this in mind, commercial banks seek a loan from the RBI for the short term. Such loans are usually against government protections. RBI loans the amount needed to the banks by buying bonds from these banks while signing an arrangement to sell them back at a later date. For example, if the RBI has fixed the repo rate at 5% while lending ₹100 Crore to a commercial bank, the premium that needs to be paid to the RBI will sit at ₹5 Crore/year.
What is Affected by a Change in Repo Rate?
Any changes in the repo rate can end up affecting various spheres of the country’s economy. This includes the impact on EMIs and even on the rates of interest on different types of personal loan, business and home loans. These changes can also end up impacting other spheres of the economy like FDs, mutual funds and savings accounts, to name a few.
Additional Read: Advantages of Home Loans for Women in India
How Does Repo Rate Work?
The repo rate plays a huge role in helping the central bank of a country, RBI in India’s case, to control the flow of funds in the market. Keeping this in mind, during inflation, the RBI raises the repo rate. What this means is that with an increased repo rate, any banks seeking to borrow money from the RBI would need to pay more interest. As a result, banks will have second thoughts about borrowing money thus restricting the money that might enter the market otherwise aiding the negation of inflation. Conversely, when there is a recession, the RBI reduces the repo rate.
What is Key Differences Between Repo Rate and Reverse Repo Rate
To help you understand the differences between the two interest rates, here is a detailed repo rate vs reverse repo rate list
Aspect | Repo Rate | Reverse Repo Rate |
Borrower and Lender Specifics | In the case of the repo rate, the lender is the RBI while the borrower is the commercial bank. | Here, the opposite holds true, the lender is the commercial bank and the borrower is the RBI. |
Importance | Helps RBI manage short-term deficiency of funds. | Decreases and controls the overall flow of money in the economy. |
Rate of Interest | Higher than reverse repo rate | Less than the repo rate |
Applicable Interest | The interest charge is defined in the repurchase agreement between the RBI and the commercial bank. | The interest charge is defined in the reverse repurchase agreement between the RBI and the commercial bank. |
Mechanism | Commercial banks get money from the RBI when the latter purchases government bonds from the former. | The RBI acquires funds from commercial banks through the deposit of their excess funds and the bank charges interest on this deposit. |
In case of a high interest rate | With high interest rates, the cost of funds goes up, making loans more expensive. | With high interest rates, the supply of money in the economy reduces since the excess funds of commercial banks are deposited with the RBI. |
In case of a lower interest rate | The cost of the funds reduces for commercial banks leading to lower interest rates on loans. | More money is supplied in the economy with lower interest rates as banks lend more and park less with RBI. |
Additional Read: Real Estate Sector Welcomes RBI's Decision to Maintain Repo Rate at 6.5%
Conclusion
Both the Repo Rate and Reverse Repo Rate are extremely important aspects that help central banks fulfil the various objectives of a country’s monetary policy. While the repo rate helps support the management of short-term liquidity in the market, the reverse repo market controls access to the excess liquidity.
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Frequently Asked Questions
What is the reverse repo rate?
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The reverse repo rate applies when the case gets reversed. So, when the RBI needs to borrow funds from commercial banks, it is charged the reverse rate.
How do repo and reverse repo rates affect the economy?
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The repo rate helps RBI manage short-term deficiency of funds while the reverse repo rate decreases and controls the overall flow of money in the economy.
Why do central banks change the repo and reverse repo rates?
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Central banks might change both the repo rate and reverse repo rate for various reasons. With a high repo rate come higher borrowing costs which can help reduce inflation though it slows down the country’s economic growth. A low repo rate has the opposite effect. Similarly, with a high reverse repo rate, banks end up depositing more money with central banks which leads to a reduction in the money in the economic system, which helps in controlling inflation
How do repo and reverse repo rates influence interest rates on loans and deposits?
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With high repo rates, the cost of funds goes up, making loans more expensive while the cost of the funds reduces for commercial banks leading to lower interest rates on loans in case of a lower repo rate.
What is the main difference between the repo rate and the reverse repo rate?
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The repo rate helps the RBI earn more by lending funds to commercial banks. The reverse repo rate, on the other hand, accumulates interest on money that has been deposited with the RBI, by the commercial banks.
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