Repo Rate vs Reverse Repo Rate
If repo and reverse repo are new words for you, it is logical to first learn something about repo rate, because it becomes easier to understand reverse repo rate then. It may come as news to many, but it is a fact that even banks face shortfall of funds in the face of increased demand for money from the customers. Though, commercial banks get money on a long term basis from the apex bank of country (Federal Reserve, incase of US, and RBI, in case of India) at a rate of interest known as bank rate, it is the short term requirements of funds that are fulfilled at another rate of interest referred to as repo rate or repurchase rate. Now that we know that banks meet their shortfall of funds through RBI at repo rate, let us see how it differs from reverse repo rate and what do these rates mean to banks and to economy in general.
It is in the hands of the apex bank to make it costlier or cheaper for the commercial banks to have money from it. When the apex bank increases repo rate, banks get funds at a higher rate of interest making it costlier for them. If the apex bank feels that the banks should increase liquidity by offering loans at lower rates, it decreases this rate, which makes available funds at the disposal of commercial banks at a lower rate of interest and banks pass on this benefit to common consumers.
Reverse repo rate is exactly the opposite of repo rate, and is the rate of interest at which commercial banks make available funds to the apex bank. You might be surprised, but there are times when even the apex bank falls short of money and this is when it asks commercial banks to grant loan to it at reverse repo rates. Reverse repo rate is always higher than repo rate, which is very attractive scenario for commercial banks as their money is at no risk when they advance it to reserve bank than when they extend money as loans to common consumers. However, even this measure means banks lend most of their excess money to the reserve bank and have very little left for common man. This measure helps check the amount of money in the economy.
While repo rate is significant to infuse liquidity in the economy by increasing or decreasing the amount of money available at the hands of banks, reverse repo is significant as it tells how liquidity in the economy is being absorbed by the reserve bank, sucking money from these banks.
What is the difference between Repo Rate and Reverse Repo Rate?
• Repo rate is the rate of interest at which the reserve bank grants short term loans to commercial banks to meet shortfall of funds faced by these banks.
• Reverse repo is the rate of interest at which the reserve bank borrows money from commercial banks to absorb liquidity in the economy
• Both repo rate as well as reverse repo are important tool to control money supply in the economy