WHAT IS REPO RATE
Updated on : 2020-Dec-31 17:18:02 | Author :
What is repo rate ?
Repo rate is that the rate at that the financial institution of a country (Reserve Bank of India.) lends cash to business banks within the event of any shortage of funds. Repo rate is utilized by financial authorities to manage inflation. Within the event of inflation, financial institutions increase the repo rate as this acts as deterrence for banks to borrow from the central bank. This ultimately reduces the money offer within the economy and therefore helps keep inflation in restraint.
The central bank takes the central position in the event of a fall in inflationary pressures. Repo and reverse repo rates type a part of the liquidity adjustment facility.
1. How Does Repo Rate Work
If you borrow money from the bank, the transaction leads interest on the principal amount. This is referred to as the value of credit. Similarly, banks also borrow money from RBI during a cash crunch on which they are required to pay interest to the central bank. Currently the rate of interest is called the repo rate.
Repo stands for ‘Repurchasing Option’ or ‘Repurchase Agreement’. it's an agreement in which banks an eligible securities such as Treasury Bills to the RBI whereas availing long loans. an agreement to repurchase them at a predetermined value will also be in place. So, the bank gets the money and therefore the central bank gets the security.
2. Components of a Repo Transaction:
These are the parameters on the basis of which the RBI agrees to execute the transaction with the banks:
Prevention of Economy “squeezes” – Depending on the inflation, the Central bank increases or decreases the Repo rate. Thus, it aims at controlling the economy by keeping inflation in the limit.
Hedging & Leveraging – RBI aims to hedge and leverage by shopping for securities and bonds from the banks and supply money to them reciprocally for the collateral deposited.
Short-Term Borrowing – RBI lends money for a short period of time, maximum being an overnight post which the banks buy back their securities deposited at a predetermined price.
Collaterals & Securities – RBI accepts collateral in the form of gold, bonds etc.
Cash Reserve (or) Liquidity – As a precautionary measure, Banks borrow money from RBI to maintain liquidity or cash reserve.
3. How Does Repo Rate Affect the Economy?
Repo rate could be a powerful arm of the Indian financial policy which will regulate the country’s funds, inflation levels, and liquidity. Additionally, the amount of repo has an instantaneous impact on the price of borrowing for banks. Higher the repo rate, higher are going to be the price of borrowing for banks and vice-versa.
A. Rise in inflation
During high levels of inflation, RBI makes strong attempts to bring down the flow of money in the economy. By increasing the repo rate it can be done. This makes borrowing a costly affair for businesses and industries, which in turn slows down investment and money supply in the market. As a result, it negatively impacts the growth of the economy, which helps in controlling inflation.
B. Increasing Liquidity in the Market
On the other hand, when the RBI needs to pump funds into the system, it lowers the repo rate. Businesses and industries find it cheaper to borrow money for various investment purposes. This also gains the overall supply of money in the economy. This ultimately boosts the growth rate of the economy.
4. What is Meant by Reverse Repo Rate?
Reverse Repo Rate is a mechanism to absorb the liquidity in the market, thus restricting the borrowing power of investors.
Reverse Repo Rate is when the RBI borrows money from banks when there is much liquidity in the market. The banks get benefit by receiving interest for their holdings with the central bank.
Throughout the time of high levels of inflation in the economy, the RBI increases the reverse repo rate. It encourages the banks to park more funds with the RBI to earn higher returns on excess funds. Banks are left with lesser funds to extend loans and borrowings to consumers.
Repo Rate VS Reverse Repo Rate
Repo rate is the rate at which RBI lends money to banks
Reverse Repo Rate is the rate at which RBI borrows money from banks
Repo rate is higher than the reverse repo rate
Reverse Repo Rate is lower than the repo rate
It is used to control inflation and deficiency of funds
It is used to manage cash-flow
Repo rate involves the sale of securities which would be repurchased in future.
Reverse repo rate involves the transfer of money from one account to another.
5. Current Repo Rate and its Impact
RBI continuously changes the repo rate and the reverse repo rate in accordance to changing macroeconomic factors. Whenever RBI modifies the rates, it impacts all sectors of the economy; though in different ways. A few segments gain as a result of the rate hike while others may face losses. Recently, RBI cut down the repo rate by 25 basis points to 5.15% from 5.75%. In the same line, the reverse repo rate was also decreased to 4.9% from 5.5%.
Changes in the repo rates will directly impact big-ticket loans like home loans. A decrease in repo rates is to focus on at transferral in growth and progressing economic development in the country. customers can borrow additional from banks therefore helpful the inflation.
A decrease in the repo rate will guide to the banks transferral down their lending rate. this could persuade be helpful for retail loan borrowers. To bring down the loan EMIs, the lender has got to scale back its base lending rate. As per the RBI, banks/financial establishments are needed to transfer the benefit of rate of interest cuts to customers as shortly as possible.
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