In this article, we will be discussing the difference between repo and reverse-repo rate. To understand reverse repo rate, we first have to understand what repo rate is.
For short term requirements, banks in India can borrow money from the Reserve Bank of India (RBI) to lend money to customers. When banks borrow money from the the Reserve Bank of India (RBI), they pay interest at a fixed rate to the Reserve Bank of India (RBI).
The rate of interest paid to Reserve Bank of India (RBI) by the banks is referred to as Repo rate.
If Reserve Bank of India (RBI) thinks that banks should get funds at a lower interest rate to increase the liquidity in the market then they reduce the repo rate by which bank’s cost of borrowing gets reduced. In return, these banks pass on the benefit of reduction in interest rates to its customers or consumers by reducing the rate of interest that they charge on loans.
Such short term lending and borrowing happens between the Reserve Bank of India (RBI) and Banks through sale or purchase of debt instruments. Under a repo transaction banks sell certain specified securities to get funds from the RBI with an agreement to repurchase them at a later predetermined date.
Based on requirements, Reserve Bank of India (RBI) may borrow money from banks by keeping securities with a commitment to resell. Reverse repo rate is the rate of interest that the Reserve Bank of India (RBI) pays to banks for the money that they borrow from banks. Reverse repo rate is the opposite of repo rate and always kept higher than the repo rate.
These interest rates are fixed from time to time by the Reserve Bank of India (RBI) based on the market conditions and inflation.
If Reserve Bank of India (RBI) decreases the Repo rate then banks find it very easy to borrow money from the Reserve Bank of India (RBI) as a result more money comes to market.
Similarly, if it increases, banks will increase the rate of interest that they charge on loans such as education loan, auto loan, home loans and personal loan. Due to higher interest rates, borrowers will not be interested to borrow money from banks, in this way money supply will be reduced to control inflation.
Conclusion
- Repo rate is the interest rate at which Reserve Bank of India (RBI) grants loans to banks.
- Reverse repo rate is the interest at which Reserve Bank of India (RBI) borrows money from banks.
