October 09, 2020

What is Repo and Reverse Repo Rate?

If you are tuned to stock market or general economic news, you would have heard this term come up every time there is central bank’s credit policy meet. Here’s an attempt to explain what does this rate mean? and how does it affect you?

What is Repo Rate?

We all put our money in bank or borrow from bank at particular interest rate. Similarly, rate at which central bank (in case of India – Reserve Bank of India aka RBI) lends money to commercial banks in the event of any shortfall of funds is called Repo rate. 

Why is it important?

This is very important tool for authorities to control inflation. In case of inflation, the central bank increase repo rate as this acts as disincentive for commercial banks to borrow from the central bank. Which effectively reduced the money supply in the economy and thus helps in arresting inflation. 

Let’s just summarize above explanation

  • Repo Rate serves as control mechanisim for the central bank for increasing / decreasing liquidity in the economy
  • Change in Repo Rate impacts the cost of borrowing for commercial banks
  • It is a key tool used by the central bank to fight inflation and achieve price stability in the economy
  • Repo rate changes can lead to changes in interest rates from deposits and interest rate applicable to loans

What is Reverse Repo Rate?

This is exactly opposite of Repo Rate. This signifies the rate at which the central bank (RBI) borrows money from the commercial banks. 

An increase in reverse Repo Rate will decrease money supply in the economy and vice-versa. Increased Reverse Repo Rate will incentivise the commercial bank to park their funds with central bank and vice-versa.

RBI Repo Rate explained

Both this rate forms part of central bank’s monetary policy instruments which helps in controlling the money supply in the country and thereby controlling the inflation.

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