What is Repo Rate and Reverse Repo Rate?

What is Repo Rate?

The repo rate is short for the repurchase rate at which commercial banks or financial institutions in India borrow money from the Reserve Bank of India against Government Securities. In a repo transaction, the central bank buys securities (such as government bonds) from commercial banks with an agreement to sell them back at a later date, usually the next day or in a few days, at a slightly higher price, effectively lending money to the banks. The repo rate is the interest rate that the central bank charges the banks for this short-term loan.

Central banks use the repo rate as an important tool to control the money supply in an economy. A central bank can affect the level of economic activity by raising or lowering the repo rate, which affects the borrowing and lending behavior of commercial banks. A higher repo rate means that borrowing money becomes more expensive for banks, which may lead to a decrease in lending and a slowdown in economic activity. Whereas, a lower repo rate may encourage banks to borrow more, which can stimulate economic growth.

What is the Current Repo Rate?

The current repo rate in 2023 stands at 6.50 percent.

What is Reverse Repo Rate?

The Reserve Bank of India borrows money from commercial banks within the country at this rate. It is an instrument of monetary policy that can be used to control the money supply.

What is the meaning of Repo Rate?

Repo Rate full form or the term ‘REPO’ stands for ‘Repurchasing Option’ Rate. It is also known as the ‘Repurchasing Agreement’. People take loans from banks in times of financial crunch and pay interest for the same. Similarly, commercial banks and financial institutions in India also face a shortage of funds. They can borrow money from the RBI bank. The Central Bank lends money to commercial banks at an interest rate on the principal amount. 

If banks take a loan against any kind of security, then this ROI is Repo Rate. Commercial banks sell eligible securities to the RBI, such as treasury bills, gold, and bond papers. When the loan is repaid, banks can repurchase the securities from the RBI. As a result, it’s known as the ‘Repurchasing Option.’ If they take a loan without pledging the securities, it is at the Bank Rate.

How Repo Rate (RR) Functions?

Banks take loans from RBI pledging securities and repurchase them the following day. The loan is an overnight fund for banks undergoing a cash crunch. Although the loan at RR is usually for 1 day, banks may need it for more than a day. The one-day loan is at Overnight Repo while more than that is a Term Repo. Term Repo is also called Variable Rate Term Repo. RBI normally announces auction for Term Repo as it can be for 7, 14, or 28 days. When inflation is higher than RBI’s standards, it increases the rate to check it. RBI increases the RR to infuse liquidity with a lower cost of funds for borrowers.

When RBI reduces the rate, it facilitates the banks to borrow, spend and invest. More money may be used for more investment purposes. Increased cash flow will lead to faster business cycles and an economic boom.

Impact on Bank Loan Rates

When the rate is high, banks have to clear off their loans to RBI with a higher interest amount. They may charge a higher rate of interest (ROI) on loans to customers to compensate for the same. RBI discourages borrowing from banks and banks discourage the customers. This drains out excess liquidity from the market and thereby controls the inflation rate.

As the rate declines, banks may also lower down their rates to seek more customers. Loan applications may be easier for customers of commercial banks as well. It expedites the demand for home loans and others. While the customers find monetary aid at a lower interest, the banks profit through it. The economy blooms due to a rushed money flow as the cost of funds goes down.

Apart from the loans, banks also adjust the interest on fixed deposits (FDs) or savings accounts as per the RR. It is a crucial benchmark according to which banks set up all kinds of rates.