The terms “Repo Rate” and “Reverse Repo Rate” is often used in the banking sector. If you have read headlines like “RBI changes key interest rates”, these are the interest rates they are talking about. Repo rate is the interest charged by RBI while repurchasing securities sold by commercial banks while reverse repo rate is the interest rate offered by RBI to commercial banks depositing their excess funds in the central bank.
Repo Rate
When a commercial bank goes through financial crisis, they approach RBI. The interest at which bank borrows funds from RBI by selling their securities and bonds is called “Repo Rate”. In other words, it is simply the rate at which The Central Bank of India lends funds to commercial banks when they are facing a financial crunch and are unable to take care of their expenses. 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 example: If 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 to RBI is Rs 1,000.
Reverse Repo Rate
Once you have understood the meaning of repo rate, reverse repo rate is self-explanatory. It is the interest rate offered by RBI to banks who deposit into their treasury. Simply put, when banks generate excess funds, they choose to deposit it in RBI which is safer than lending it to their account holders or other companies. The rate of interest earned by the depositing bank is called reverse repo rate. For example: If the reverse repo rate fixed by RBI is 5% p.a and the amount deposited by commercial banks into RBI’s account is Rs. 10,000, the interest rate by the depositing bank is Rs 500 p.a.
5 Major differences between Repo Rate and Reverse Repo Rate
- Repo rate is charged by RBI when commercial banks sell their securities. Whereas, reverse repo rate is the rate at which RBI borrows money from banks within the country.
- While high repo rate drains excess liquidity from the market as the banks have to pay high interest to obtain loan from RBI, high reverse repo rate injects liquidity into the economic system by offering high profits to banks.
- The repo rate is always higher than the reverse repo rate.
- While repo rate is used to control inflation, reverse repo rate is used to control money supply in the market.
- The main objective of repo rate is to deal with deficiency of funds. Whereas, reverse repo rate deals with liquidity in the economy.
- Repo Rate involves selling securities to RBI with a motive to repurchase it in the future at a fixed rate of interest but reverse repo rate is mere transferring of funds from one bank account to RBI account.
