The Reserve Bank of India (RBI), has on 7 August 2019, revised its repo rate to 5.40% as on 6 June 2019. There has been a decrease in the repo rate by 35 basis points over the previous repo rate of 5.75%. The reverse repo rate stands at 5.15% at present.
The Central Bank of the country decreased the key rates for the fourth time in a row this calendar year.
Difference between Repo Rate and Reverse Repo Rate
On 4 April 2019, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) revised the repo rate. This rate was decreased by 25 basis points, from 6.25% to 6%.
Even the reverse repo rate saw revisions with a decrease of 25 basis points, which now stands at 5.75%. The previous reverse repo rate, which was revised on 1 August 2018, stood at 6%.
To understand how this affects you and your loans, you need to know what’s the difference between the repo rate and reverse repo rate.
When commercial banks approach the Reserve Bank of India for funds, they’re charged a certain amount of interest. The rate at which RBI lends these finances to commercial banks is called the repo rate.
In this case, a repurchasing agreement is signed by both the parties, stating that the securities will be repurchased on a given date at a predetermined price. For instance, let’s assume the repo rate fixed by the RBI is 10% p.a. and the amount borrowed by a bank from RBI is Rs.10,000. The interest rate to be paid by the bank will be Rs.1,000.
The repo rate in India is fixed and monitored by India’s central banking institution, the Reserve Bank of India. It allows the central bank to control liquidity, money supply, and inflation level in the country.
To decrease the money supply in the economy, the RBI will hike up the repo rate to discourage banks from borrowing funds. Similarly, if the RBI wants to pump funds into the system, the may reduce the repo rate, thus encouraging banks to go ahead and borrow funds.
Reverse Repo Rate
Reverse repo rate is the interest offered by the RBI to banks who deposit funds into the treasury. For instance, when banks generate excess funds, they may deposit the money in the central bank. This is a much safer approach when compared to lending it to other companies or account holders.
So, the interest earned on the deposited funds is known as the reverse repo rate. As an example, let’s assume the reverse repo rate is 5% p.a. A commercial bank has deposited Rs.10,000 in the central bank. This means, the commercial bank will earn Rs.500 p.a. as interest.
This is another financial instrument used by the RBI to control the supply of money in the nation. In case the RBI is falling short on money, they can always ask commercial banks to pitch in with funds and offer them great reverse repo rates in return. This gives banks and other financial institutions the opportunity to earn profit on excess funds.
5 Major differences between Repo Rate and Reverse Repo Rate
Besides the way these rates work, there are other differentiators you should know of:
- A high repo rate helps drain excess liquidity from the market, whereas a high reverse repo rate helps inject liquidity into the economic system.
- The repo rate is always higher than the reverse repo rate.
- Repo rate is used to control inflation and reverse repo rate is used to control the money supply.
To conclude, the major difference between these two is that an increase in the repo rate will make commercial banks borrow less. Whereas an increase in the reverse repo rate will allow commercial banks to transfer more funds to RBI, which contributes to the money supply.