Repo Rate vs MSF 2025

Commercial banks receive funding from the central bank by selling it government securities or other financial assets. The commercial banks consent to buy back these securities in the future at a higher price, typically within a short time frame, frequently overnight or for a few days. 

The repo rate is a tool used by the RBI to carry out its monetary policy. They can affect the overall level of liquidity in the financial sector by altering the repo rate. Reducing the repo rate encourages banks to take on more debt, which adds liquidity to the system and boosts the economy.

On the other hand, increasing the repo rate increases the cost of borrowing, reduces liquidity, and might even slow inflation. Repo transactions are a common way for commercial banks to get short-term funding. By using their securities as collateral in a repo deal with the central bank or other financial institutions, they can swiftly raise cash. 

What is the Marginal Standing Facility Rate (MSF)?

The MSF or Marginal Standing Facility (MSF) Rate is the rate at which RBI lends funds overnight to scheduled banks, against government securities. RBI has introduced this borrowing scheme to regulate short-term asset liability mismatches in a more effective manner. The MSF Rate is usually 25 basis points higher than the current repo rate.

A crucial interest rate set by the Reserve Bank of India (RBI) as part of its monetary policy framework is the Marginal Standing Facility (MSF) rate. Scheduled commercial banks in India can borrow money from the RBI on an overnight basis through the MSF window in exchange for their qualified securities. The repo rate, which is the rate at which banks can borrow money from the RBI through the repo market, is normally set at a slightly higher level than the MSF rate. 

To encourage banks to first try borrowing through the repo market, where rates are often lower, the MSF rate is set higher than the repo rate. Only when faced with extraordinary circumstances or unable to borrow at the repo rate, may banks turn to the MSF. 

Key Differences between Repo Rate and MSF

Both repo rate and MSF are rates at which RBI lends money to various other banks. However, there are some differences between the two, they are:

1. The repo rate is applied to loans given to banks that are looking to meet their short-term financial needs. While the MSF is meant for lending overnight to banks.
2. Repo rate is the rate at which money is lent by RBI to commercial banks, while MSF is a rate at which RBI lends money to scheduled banks.
3. Lending at repo rates involves selling the bank's securities as collateral to RBI along with a repurchase agreement. Loans given at MSF rates involve providing government securities as collateral.
4. Another major difference between the MSF and repo rate is that MSF banks are allowed to use the securities that come under Statutory Liquidity Ratio (SLR) in the process of availing loans from RBI.
   

Advantages of Repo Rate 

The following are the advantages of repo rate: 

1. Controls inflation: The RBI uses the repo rate as a key tool in its battle against inflation. When inflation is on the rise, the RBI might increase the repo rate to make borrowing more expensive, which can aid in lowering consumer spending and reducing pressures associated with demand-side inflation. 
2. Risk Mitigation: Repo deals frequently include collateral, which lowers risk for both the RBI and the borrowing banks. The RBI can sell the collateral to recoup the cash in the event that a borrowing bank breaches the repurchase agreement, reducing credit risk. 
3. Liquidity Management: The RBI can control the banking system's liquidity requirements thanks to the repo rate. In particular, banks frequently use the repo window to receive short-term cash in order to satisfy their daily reserve obligations. The RBI can change the repo rate to add or remove liquidity as necessary to keep the financial system stable. 
4. Exchange Rate Stability: The RBI can affect the value of the Indian rupee by changing the repo rate. Changes in the repo rate can encourage or deter foreign capital flows, altering the value of the rupee and, in turn, the competitiveness of the nation's exports. 

1. Crisis Management: The RBI can utilise the repo rate and other monetary policy tools to provide liquidity to the banking system during financial crises or periods of economic hardship. By doing so, systemic failures are avoided and financial markets are stabilised.

Disadvantages of Repo Rate 

The following are the disadvantages of repo rate: 

1. Limited Impact of Real Economy: It's possible that changes in the repo rate don't always have a direct or noticeable effect on the real economy. How effectively changes in the repo rate are communicated to consumers and companies can be influenced by a number of variables, including transmission lags, banks' risk aversion, and the demand for credit. In some circumstances, it could take some time before rate changes have an impact on how much people borrow and spend. 

1. Asset Price Inflation: Investors may seek bigger returns in riskier assets like equities and real estate if repo rates are low in the environment. This may be a factor in asset price inflation, which causes a sharp increase in the price of these assets with the potential to lead to bubbles and financial instability. 
2. Inflation Risk: If demand in the economy rises too high, lowering the repo rate to promote economic growth runs the risk of escalating inflation. For the RBI, maintaining a balance between encouraging growth and reducing inflation can be challenging. 

Advantages of MSF Rate 

The advantages of MSF rate are mentioned below: 

1. Emergency Funding: For banks that have unanticipated liquidity issues, the MSF rate acts as a source of emergency funding. In stressful or unforeseen circumstances, like abrupt deposit withdrawals or disruptions in the interbank lending market, this facility offers banks a safety net. 
2. Interest Rate Management: Banks are discouraged from using the MSF rate as their principal source of borrowing because it is set higher than the repo rate. This aids the RBI in influencing the economy's short-term interest rate structure. Banks are encouraged to look for lower-cost borrowing options before using the MSF, such as the repo market, in the interbank market. 
3. Short Term Borrowing: MSF loans normally have a one-day maturity and are extremely short-term. Because they are short-term, banks can use them to fill temporary liquidity holes without turning to riskier, longer-term borrowing arrangements.

Disadvantages of MSF Rate 

The disadvantages of MSF rate are mentioned below: 

1. Higher Cost of Borrowing: To deter banks from using it as their main source of funding, the MSF rate is often set higher than the repo rate. Banks with a lack of liquidity may find it difficult to get capital through the MSF window as a result of this higher borrowing cost. 
2. Impact on Borrowers: As banks may pass on these higher funding costs to their customers in the form of higher interest rates on loans, the greater cost of borrowing through the MSF can have an indirect effect on borrowers. Both firms and people may find borrowing to be more expensive as a result. 
3. Risk of Overuse: There could be a moral hazard problem if banks rely too heavily on the MSF when things become tough. Banks may not take the proper precautions to control their liquidity concerns if they believe the MSF to be a readily available source of capital. 

Effect of Repo Rate:

The higher the repo rate,the higher is the value of the short-term money. If the repo rate is low, banks are required to pay lower interest amount towards loans. This impacts the loans taken by customers, who can also avail themselves of loans at lower interest rates.

Effect of MSF Rate:

The MSF is maintained at 25 bps higher than the repo rate. MSF basically provides a greater liquidity cushion. The higher the MSF rate, the more expensive is borrowing for banks, as well as corporate borrowers and individuals. It is used by RBI to control the money supply in the country's financial system.

The monetary policy committee (MPC) of the Reserve Bank of India (RBI) has hiked the repo rate by 25 basis points to 6.50% on 8 February 2023. The MSF Rate was increased to 6.75%. Previously on 7 December 2022, the repo rate was increased by 35 basis points to 6.25% while the MSF Rate was 6.50%.