What is Repo Rate

Definition: Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.

Description: In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in arresting inflation.

The central bank takes the contrary position in the event of a fall in inflationary pressures. Repo and reverse repo rates form a part of the liquidity adjustment facility.

All that you need to know about Repo Rate. Watch video....

1. What is repo rate and reverse repo rate?
   Repo Rate: It is the interest rate at which the central bank of a country lends money to commercial banks. The central bank in India i.e. the Reserve Bank of India (RBI) uses repo rate to regulate liquidity in the economy. In banking, repo rate is related to ‘repurchase option’ or ‘repurchase agreement’.When there is a shortage of funds, commercial banks borrow money from the central bank which is repaid according to the repo rate applicable. The central bank provides these short terms loans against securities such as treasury bills or government bonds. This monetary policy is used by the central bank to control inflation or increase the liquidity of banks. The government increases the repo rate when they need to control prices and restrict borrowings. On the other hand, the repo rate is decreased when there is a need to infuse more money into the market and support economic growth.An increase in repo rate means commercial banks have to pay more interest for the money lent to them and therefore, a change in repo rate eventually affects public borrowings such as home loan, EMIs, etc. From interest charged by commercial banks on loans to the returns from deposits, various financial and investment instruments are indirectly dependent on the repo rate. Reverse Repo Rate: This is the rate the central bank of a country pays its commercial banks to park their excess funds in the central bank. Reverse repo rate is also a monetary policy used by the central bank (which is RBI in India) to regulate the flow of money in the market.When in need, the central bank of a country borrows money from commercial banks and pays them interest as per the reverse repo rate applicable. At a given point in time, the reverse repo rate provided by RBI is generally lower than the repo rate. While repo rate is used to regulate liquidity in the economy, reverse repo rate is used to control cash flow in the market. When there is inflation in the economy, RBI increases the reverse repo rate to encourage commercial banks to make deposits in the central bank and earn returns. This in turn absorbs excessive funds from the market and reduces the money available for the public to borrow.
2. What is the current repo?
   Repo rate is the rate at which commercial banks borrow money from the central bank of a country (which in the case of India is the Reserve Bank of India or RBI) when they are in the need of funds. On the other hand, reverse repo rate is the interest rate paid to commercial banks when they deposit their excess funds in the central bank or when the central bank borrows money from them. As of April 2021, RBI’s repo rate stands at 4% and reverse repo rate at 3.35%. The repo rate was reduced by 40 basis points from 4.4% to 4% and the reverse repo rate was pegged at 3.35% in May 2020. RBI has kept these crucial rates unchanged since the last five sessions to accommodate the current economic situation.RBI keeps revising the repo rate and reverse repo rate periodically according to the state of the economy. Every sector of the economy is affected by changes made to these interest rates. Most banks have an RRLR or repo rate linked lending rate and when the repo rate is revised, banks are directed by RBI to change the interest rate applicable on various loans accordingly. Generally, when the repo rate is reduced, the interest rate charged on home loans, EMIs etc. also reduces, making it easier for customers to avail loans or borrow from banks. This in turn helps in the economic growth of the country. Though changes made to repo rates are meant to affect the interest rate of commercial banks, the actual rates applicable for the customer may vary from bank to bank and is also dependent on various factors including the terms of the loan such as the amount being borrowed, tenure of repayment, etc.
3. What are SLR and CRR?
   SLR: Statutory liquidity ratio or SLR refers to the minimum percentage of deposits that needs to be maintained by commercial banks in the form of liquid assets, cash, gold, government securities, etc. SLR is essentially a portion of the bank’s Net Demand and Time Liabilities (NDTL) or total demand deposits and time-based deposits. The limit of SLR for commercial banks is decided by the central bank of the country (Reserve Bank of India or RBI in India) but the deposits are maintained by the respective banks themselves. However, the SLR cannot be used by the bank for lending. The deposits designated towards SLR are eligible for earning interests. This monetary policy of the RBI is aimed at ensuring the solvency of the banks or ensuring that the banks, at any point in time, are capable of paying back their liabilities. This in turn ascertains that the depositor’s money is safe and helps in increasing their confidence in the bank. SLR is used to regulate inflation and maintain cash flow in the economy. When there is inflation, RBI increases the SLR to restrict the lending capacity of the bank. And when there is a need to infuse cash into the system, RBI reduces the SLR to help banks offer loans at better rates and improve borrowings.CRR: Cash reserve ratio or CRR is a portion of a commercial bank’s total deposits that needs to be maintained at the central bank of the country (which is RBI in India). Just like SLR, the limit of CRR to be maintained is also determined by RBI. However, here the deposit is in the form of liquid cash and has to be kept in an account with the RBI.Banks are not allowed to utilise the CRR deposited for giving out loans or for other lending purposes. Apart from that, CRR deposits are also not eligible for earning interests. CRR helps in ensuring that the bank always has enough cash to disburse when depositors need it.The purpose of this monetary policy is to check inflation in the economy. When CRR is increased, the cash reserves of commercial banks are depleted which limits their lending capacity. This reduces borrowings and helps in controlling inflation.
4. What is the meaning of repo?
   Repo stands for ‘repurchase option’ or ‘repurchase agreement’. It is a form of short term borrowing that allows banks or financial institutions to borrow money from other banks or financial institutions against government securities with an agreement to buy those securities back after a specified time period and at a predetermined price (which is higher than the initial sell price).A repurchase agreement is a secured way of raising short-term capital for banks. The duration of these loans generally varies between one day to a fortnight. In this system, the borrower enters into a repo or repurchase agreement, whereas, for the lender, it’s a reverse repurchase agreement or reverse repo.In India, the Reserve Bank of India or RBI (which is the central bank in the country) lends money to commercial banks with an interest rate which is called repo rate. These loans are sanctioned in exchange for securities to help the banks achieve their financial goals. On the other hand, RBI also has provisions for banks to park their excessive funds for which RBI pays interest, which is determined by reverse repo rate. This interest rate is also applicable when RBI borrows money from commercial banks. RBI uses repo and reverse repo to maintain economic stability in the country. When there is a need for an economic boost, RBI pumps funds into the system by helping commercial banks borrow money from the bank. Using repo, banks raise the necessary capital to increase their lending capacity. This ensures liquidity for the bank and proper cash flow into the market. But, in the case of inflation, RBI uses reverse repo to absorb funds from the market to regulate the lending capabilities of commercial banks.
5. What is repo rate by RBI?
   Repo rate is the rate of interest at which commercial banks in India borrow money from the Reserve Bank of India. Commercial banks are required to deposit securities such as government bonds or treasury bills as collateral to avail these loans from the central bank of the country. These are generally short term loans that banks take when there is a shortage of cash.Just like the repo rate, RBI also has a reverse repo rate which is the rate that the RBI pays to the commercial banks when they deposit their excess funds in the central bank. Reverse repo rate is generally lower than the repo rate.In a bi-monthly monetary meet held on April 7, 2021, RBI announced that the current repo rate has been kept at 4% and the reverse repo rate at 3.35%. This is the fifth time in a row that these crucial rates haven’t been revised. In May 2020, the repo rate was reduced by 40 basis points from 4.4% to 4% and the reverse repo rate was made 3.35%.Repo rate and reverse repo rate are monetary policies used by RBI to maintain economic stability in the country. Suppose the country is going through a cash crunch. In this case, RBI will reduce the repo rate to help banks borrow more and make loans available to the public at reduced rates. Now, if the country’s economy is experiencing inflation, RBI will increase the reverse repo rate to limit borrowings by commercial banks. This, in turn, will reduce their lending capacity and keep inflation in check.
6. What is MSF rate?
   MSF or marginal standing facility is a system of the Reserve Bank of India that allows scheduled commercial banks to avail funds overnight. The interest rate charged by RBI on such borrowings is called the MSF rate or marginal standing facility rate. RBI has introduced this provision to help scheduled banks when inter-bank liquidity completely dries up and they are in urgent need of money. MSF is sanctioned against government securities and the MSF rate is around 100 basis points or one percent higher than the repo rate. These loans fall under RBI’s liquidity adjustment facility or LAF. The maximum amount that can be availed under MSF is a percentage of the bank’s NDTL or net demand and time liabilities. Banks can use their SLR or statutory liquidity ratio to take loans under MSF. This is a short-term loan used to maintain the liquidity of banks. MSF helps in reducing the volatility of overnight lending rates and helps banks manage situations where there is a short-term asset liability mismatch. RBI uses this monetary policy to regulate the supply of funds into scheduled banks and also ensures safety for the depositors. Though limited, but the MSF rate at which banks borrow money from RBI can also affect retail loans. Generally, loans rates available for the public tend to get cheaper when MSF rate decreases and vice versa. Moreover, RBI also revises the MSF rate to strengthen the value of rupee, when required. Monetary standing facility was introduced by the RBI as a provision for banks to avail overnight funds during a revision of the country’s monetary policy in 2011-12.