REPO RATE AND REVERSE REPO RATE

BY:

AHANA MOHAN & SABITA MUNDARI

WHAT IS REPO RATE?

Repo or repurchase option is a means of short-term borrowing, wherein banks sell approved government securities to RBI and get funds in exchange. In other words, in a repo transaction, RBI repurchases government securities from banks, depending on the level of money supply it decides to maintain in the country's monetary system.

Repo rate is the discount rate at which banks borrow from RBI. Reduction in repo rate will help banks to get money at a cheaper rate, while increase in repo rate will make bank borrowings from RBI more expensive. If RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate. Similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

PURPOSE OF REPO RATE

Repo rate is an important tool used by the RBI to control the supply of money in the banking system. If the rate is increased, the banks will find it difficult to borrow from RBI and the cost of fund will increase. This will result in an increase in interest rate in the system. By reducing the Repo rate RBI can reduce the cost of borrowing and there by the interest rate in the system

WHAT IS REVERSE REPO RATE?

Reverse Repo rate is the rate at which the RBI borrows money from commercial banks. Banks are always happy to lend money to the RBI since their money are in safe hands with a good interest. An increase in reverse repo rate can prompt banks to park more funds with the RBI to earn higher returns on idle cash. It is also a tool which can be used by the RBI to drain excess money out of the banking system.

Reverse repo is the exact opposite of repo. In a reverse repo transaction, banks purchase government securities form RBI and lend money to the banking regulator, thus earning interest.

PURPOSE OF REVERSE REPO RATE

RBI uses Reverse Repo Rate to control liquidity in the system. If RBI increases the Reverse Repo rate, it indicates its readiness to accept money at a higher rate. Cash rich banks will use this facility to park their surplus money with RBI.

What way a common man is affected by these rates?

The banks will decide the interest rates based on their cost of funds. Repo Rate will affect the rate of interest charged by banks on various loans like Home Loan, Personal Loan, car loan etc. As customers of various loans, all of us will be affected by these rates indirectly.

What way Repo rate and Reverse Repo Rate is Connected?

As per the current practice, the Reverse Repo Rate is maintained at 100 basis points lower than the Repo Rate. It simply means, if any bank want to borrow from RBI, it will pay 100 basis point more than what it will get, while parking their money with RBI.

Why Repo Rate is always higher than Reverse Repo Rate?

Repo rate is always higher than Reverse Repo Rate, otherwise it will give an opportunity of arbitrage. Example: Here we are assuming that Reverse Repo Rate(8%) is higher than Repo Rate(7%).Suppose ABF Bank has Rs. 100 in system, it will park all the money with RBI and will borrow the same amount from RBI at a lower interest rate. So the bank will earn an extra 1% of interest without any risk, which we call as arbitrage.

Who decides the Repo Rate and Reverse Repo Rate?

The Reserve Bank of India (RBI) will be declaring the above rates, after studying the needs of the market and the future trends. These rates are the most important tools in the hands of RBI to control liquidity of money in the system.

REFERENCE
www.paisatalks.com en.wikipedia.org www.banks-india.com www.moneycontrol.com flame.org.in www.investopedia.com www.kerelabanking.com