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 is repo rate.
For short term requirement, banks in Indian can borrow money from RBI to lend to customers. When bank borrow money from RBI, they pay a fixed interest percentage in return to RBI. The interest percentage is called repurchase or Repo rate.
If RBI thinks that bank should get fund at a lower interest to increase the liquidity in market then they reduce the repurchase rate by which bank’s cost of borrowing get reduced. In return, these banks pass on the benefit of reduction in repurchase rate to its customers or consumers by reducing the interest percentage.
Such short term lending and borrowing happens through sale or purchase of debt instruments. Under a repo transaction banks sell certain specified securities to get fund from RBI with an agreement to repurchase them at a later predetermined date.
Based on requirements, RBI may borrow money from banks by keeping securities with a commitment to resell. Reverse repo rate is the interest percentage that RBI pays to bank for the money that they borrow from banks. Reverse repo is the opposite of repurchase rate and always kept higher that the repo rate.
Repo and reverse repo rate is fixed from time to time by RBI based on the market conditions.
If RBI decreases the Repo rate then banks find it very easy to borrow money from RBI as a result more money comes to market. Similarly, if it increases, banks will not be willing to borrow money from RBI or if they borrow for some reason then it will impact the loan interest percentage in that proportion to bank’s customers.
- Repurchase rate is the interest at which RBI grants loan for short term requirements of bank.
- Reverse repo rate is the interest at which RBI borrows money from banks.