What are Repo Rates and Reverse Repo Rates?

In the context of the Indian economy, repo rate and reverse repo rate are two crucial concepts. Both are extremely important for stabilising liquidity and controlling inflation. Repo and Reverse Repo rates are a guarantee that the money supply in the market is reasonable and sufficient. The RBI sets and controls these rates for the national monetary policy. Here is an attempt to provide our readers with a clear explanation of both words and a comparison of the two rates. The impact of a rise or fall in these rates is another goal of the essay. Repo Rate vs. Reverse Repo Rate demonstrates their main distinctions and points of similarity.

What is Repo Rate?

The Reserve Bank of India (RBI) provides loans to commercial banks in India in exchange for securities such as bonds, treasury bills, and government securities. Once the main loan amount and additional interest, computed at the Repo Rate or Repurchasing Option Rate, are paid, they make the offer to buy these securities. The terms and conditions of the agreement between banks and the RBI include the option to repurchase securities at a particular price and date. Banks may also accept loans at the Bank Rate without requiring securities as collateral; the primary reason for the disparity between the bank rate and repo rate is the collateral provision.

What is Reverse Repo Rate?

Because of how provocative the title "Reverse Repo Rate" sounds, it is the opposite of the repo rate. As a result, the terms of borrowing and lending conflict with that repo rate. In this case, interest is paid by the Central Bank on loans it takes from commercial banks. For a brief period, the RBI promises securities to banks in exchange for their willing deposit of excess funds. Put differently, the RBI offers incentives to banks in exchange for their deposits. In a repurchase agreement, the RBI repurchases the securities at this interest rate. Securities from the state governments, FI bonds, corporate and PSU bonds, etc. are among them. By understanding what repo rate and reverse repo rate are, you can simply clear your concept about various things related to banks & RBI.

How is the Repo Rate Calculated?

To overcome asset shortages, the RBI offers banks short-term liquidity loans that are usually guaranteed by government assets. In this short-term lending and borrowing practice, the RBI buys bonds from commercial banks with the promise to repurchase them later. More generally, if a commercial bank borrows Rs.100 crore and the RBI sets the repurchase rate at 5%, the annualised interest paid to the central bank will be Rs. 5 crores. Repurchase Rate India, a component of the RBI's monetary policy, is the formula used in this computation.

The following formula was utilised to determine the RBI Repurchase Rate in the aforementioned example:

Repo Rate = ((Repurchase Price – Original Selling Price) / Original Selling Price) * (360 / n)

where ‘n’ is the number of days to maturity, and the original selling price is the sales cost of the security.

 

How Does Repo Rate Work?

The repo rate, as previously stated, is used by the Indian central bank to limit the flow of money in the market. When inflation influences the market, the RBI hikes the repo rate.

With a raised repo rate, banks borrowing money from the central bank during this period will have to pay more interest. This discourages banks from borrowing money, lowering the amount of money in the market and aiding in the prevention of inflation. In the case of a recession, the RBI repo rates are decreased as well.

Difference Between Repo Rate and Reverse Repo Rate

Here are the differences between the repo rate and the reverse repo rate:

ParametersRepo RateReverse Repo Rate
Lender & BorrowerRBI lends, commercial banks borrowBanks lend, RBI borrows
Operation MechanismBanks pledge securities to take loans from RBIRBI pledges securities to banks for loans or deposits
Rate of InterestHigher than reverse repo rateComparatively lower than the repo rate
ROI ApplicableBanks repay loans to RBI at repo rate with interestBanks withdraw money from RBI at reverse repo rate with interest
Purpose/ObjectiveControls inflation and deficiency of moneyControls overabundance of funds and cash flow
Impact of Increase in RateDiscourages banks from borrowing, leading to expensive loans for customersReduces money supply in the market as banks deposit more funds in RBI for higher interest
Impact of Decrease in RateEncourages lending to banks, reducing loan rates for customersExcess funds as banks withdraw deposits from RBI, increasing lending in the market

What is the Impact of Reverse Repo Rate?

In response to shifting macroeconomic conditions, the RBI modifies the repurchase rate and reverse repurchase rate, which has varying effects on different economic sectors. The 35 basis point increase in the repurchase rate from 5.90% to 6.25%, with the reverse repurchase rate staying at 3.35%, is one recent example.

Large loans, such as house loans, may be directly impacted by changes in the buyback rate. Reducing repo rates encourages customers to borrow more from banks, which stabilises inflation and promotes growth and economic progress.

Banks may lower their lending rates in response to a decline in the repurchase rate, which would help consumers who take out retail loans. Following RBI requirements, which mandate that banks and financial institutions swiftly pass on interest rate reductions to customers, lenders must drop their base lending rates to lower loan EMIs.

Conclusion 
Overall, the repo rate and the reverse repo rate are essential instruments used by central banks to accomplish monetary policy goals. While the reverse repo market aids in removing excess liquidity from the financial system, the repo market makes short-term liquidity management easier. Investors, politicians, and everyone else interested in understanding the complex workings of the financial sector must grasp the subtleties of these rates. For a better understanding do use the reliable stock market app.

FAQs on Repo Rate and Reverse Repo

The RBI maintains the 6.5% repurchase rate. At a repo rate, which is set at 6.50% in 2023, the Reserve Bank of India (RBI) extends loans to Indian commercial banks and other financial institutions in exchange for government assets.

The Monetary Policy Committee (MPC) said on February 8, 2023, that the repo rate will increase by 0.25%, to 6.50%. This modification came after the buyback rate was raised to 6.25% on December 7, 2022.

Repo rate is calculated as (360 / n) * ((Repurchase Price – Original Selling Price) / Original Selling Price. where ‘n’ is the number of days to maturity, and the original selling price is the sales cost of the security.

The current repo rate is 6.50% in India.

The repo rate is set by the Reserve Bank of India's Monetary Policy Committee (MPC).