What is Repo rate and Reverse Repo rate? What is its implications!

What is the “Repo Rate”?

The repo rate is the rate at which a country's central bank (Reserve Bank of India in the case of India) lends money to commercial banks in the event of a cash shortage. The repo rate is used by monetary authorities to control inflation.

In the event of inflation, central banks increase the repo rate as this discourages banks from borrowing from the central bank. Ultimately, this reduces the money supply in the economy, helping to stop inflation.

When inflationary pressures ease, the central bank takes the opposite position. The repo and reverse repo rates are part of the liquidity equalization facility.

     

What is repo rate and reverse repo rate?

Repo Rate: This is the rate at which a country's central bank lends money to commercial banks. The Indian central bank, i.e., the Reserve Bank of India (RBI), uses the repo rate to regulate liquidity in the economy. In the banking industry, the repo rate is tied to a “call option” or “purchase agreement”. If there is a liquidity shortage, the commercial banks borrow money from the central bank, which is repaid at the prevailing repo rate. The central bank makes these short-term loans against securities such as Treasury bills or government bonds. This monetary policy is used by the central bank to control inflation or increase banks' liquidity. The government raises the repo rate when it needs to control prices and limit borrowing. On the other hand, the repo rate is lowered when there is a need to inject more money into the market and support economic growth. An increase in the repo rate means that commercial banks have to pay more interest on the money they borrow, and hence a change in the repo rate ultimately affects government loans such as mortgage loans, EMI, etc. From interest rates on commercial bank loans to income from deposits, various financial and investment instruments depend indirectly on the repo rate. Reverse Repo Rate – This is the rate a country's central bank pays its commercial banks to park their excess funds with the central bank. Reverse Repo Rate is also a monetary policy used by the Central Bank (RBI in India) to regulate the flow of money in the market. When necessary, a country's central bank borrows money from commercial banks and pays them interest at the prevailing repo rate. The Reverse Repo Rate provided by RBI is generally lower than the Reverse Repo Rate at any point in time. While the reverse repo rate is used to regulate liquidity in the economy, the reverse repo rate is used to control the flow of money in the market. When there is inflation in the economy, the RBI raises the reverse repo rate to encourage commercial banks to make deposits with the central bank and earn yields. This in turn absorbs excess funds from the market and reduces the money available for the public to borrow.

What is the current deposit?

The repo rate is the rate at which commercial banks borrow money from a country's central bank (in the case of India, the Reserve Bank of India or RBI) when they need money. On the other hand, reverse repo rate is the interest rate paid to commercial banks when they deposit their excess funds with the central bank or when the central bank borrows money from them. As of April 2021, the RBI repo rate is 4% and the reverse repo rate is 3.35%. The repo rate was cut by 40 basis points from 4.4% to 4% and the reverse repo rate was set at 3.35% in May 2020. The RBI has kept these policy rates unchanged for the past five recent meetings to reflect the current economic climate. RBI regularly adjusts the repo rate and the reverse repo rate depending on the economic situation. All sectors of the economy are affected by changes in these interest rates. Most banks have a lending rate linked to the repo rate or RRLR, and when the repo rate is revised, the RBI directs banks to change the interest rate applicable to different loans accordingly. Typically, when the repo rate drops, the interest rate on mortgages, EMI, etc. also low, making it easier for customers to obtain credit or borrow from banks. This in turn contributes to the economic growth of the country. Although changes in reverse repo rates are intended to affect the interest rate charged by commercial banks, the actual interest rates charged to the customer may vary from bank to bank and also depend on various factors, including the terms of the loan, such as the amount borrowed, repayment term, etc.

What are SLR and CRR?

SLR: The Legal Liquidity Ratio or SLR refers to the minimum percentage of deposits that commercial banks must hold in the form of cash, cash, gold, government securities, etc. The SLR is essentially a portion of the Bank's Net Demand and Term Liabilities (NDTL), or total demand and term deposits. The SLR limit for commercial banks is set by the central bank of the country (Reserve Bank of India or RBI in India), but the deposits are managed by the respective banks themselves. However, the SLR cannot be used by the bank for lending. Deposits to SLRs may earn interest. RBI's monetary policy aims to ensure the solvency of banks or to ensure that banks can pay their obligations at any time. This, in turn, ensures that the depositor's money is safe and helps to increase their confidence in the bank. The SLR is used to regulate inflation and maintain cash flow in the economy. In case of inflation, the RBI increases the SLR to limit the lending capacity of the bank. And when there is a need to inject liquidity into the system, the RBI lowers the SLR to help banks offer credit at better rates and improve lending. CRR: Cash Reserve Ratio or CRR is part of the total deposits of a commercial bank which must be kept with the central bank of the country (RBI in India). As with the SLR, the RBI also sets the limit to be monitored for the CRR. However, the deposit here is in cash and must be held in an account with the RBI. Banks cannot use the submitted CRR for loans or other lending purposes. Apart from that, CRR deposits also do not earn interest. The CRR ensures that the bank always has enough cash to pay when depositors need it. The purpose of this monetary policy is to curb inflation in the economy. If the CRR is raised, the liquidity reserves of commercial banks will be depleted, which will limit their lending capacity. This reduces debt and helps control inflation.

What does repo mean?

Repo means "purchase option" or "purchase agreement". It is a form of short-term lending that allows banks or financial institutions to borrow money from other banks or financial institutions against government securities with an agreement to sell those securities after a specified period of time and at a predetermined price (which is higher than the initial selling price). A repurchase agreement is a safe means for banks to raise capital in the short term. The terms of these loans generally vary from one day to two weeks. In this system, the borrower enters into a repurchase agreement or repurchase agreement, while the lender enters into a reverse repurchase agreement or reverse repurchase agreement. In India, the Reserve Bank of India or RBI (the country's central bank) lends money to commercial banks at a rate known as the repo rate. These loans are made in exchange for securities to help banks achieve their financial goals. On the other hand, the RBI also has provisions for banks to park their excess funds, on which the RBI pays interest determined by the reverse repo rate. This interest rate also applies when RBI borrows money from commercial banks. RBI uses repo and reverse repo to maintain the country's economic stability. When it is necessary to stimulate the economy, the RBI injects funds into the system by helping commercial banks borrow money from the bank. Repos provide banks with the capital they need to increase their lending capacity. This ensures the bank's liquidity and an appropriate cash flow on the market. But in the event of inflation, the RBI uses reverse repos to absorb funds from the market to regulate commercial bank borrowing.