Newspapers are flooded with news related to banking sector news… The financial market… Repo rates … Reverse repo rates… RBI decreased or increased its key interest rates and we all get confused how they are related to our financial system or our financial needs. How the loans we borrow are affected with these minute changes? A common man is always curious to know more and more about these terms. We are sure the following article will solve your doubts and queries.
The central monetary authority of India is Reserve Bank of India (RBI) which is designed to maintain the price stability in our country. The central bank or RBI controls the supply of money by controlling the interest rates to achieve high economic growth. The banks and other financial institutions also borrow from RBI and the interest charged for providing funds to the banking system is known as the Bank Rate. This banking system involves the commercial, co-operative banks and other approved financial institutions. Funds are provided by lending directly to the banks/ NBFC’s or by buying money market instruments. Increase in bank rates increases the cost for borrowing by the banks/ NBFC’s which in turn reduces the money supply. RBI increases the bank rate to tighten the monetary policies.
Repo Rate is the rate on which RBI lend its fund to its customers (commercial banks) in case of any shortfall of funds. Generally the lending is against the government securities. Reduced repo rates help the commercial banks to get the money on cheaper rates whereas an increase in repo rates makes the funding expensive. Increase in repo rates increase the cost of borrowing for customers also and they deposit more instead of borrowing. Inflation decreases due to high rates and decreased demand of credit. Repo rate is a monetary tool to control inflation. During inflation repo rate is increased by RBI and discourage the banks to borrow from the central bank. This in turn reduces the supply of funds in the economy and helps to control the inflation.
Reverse repo rate is the rate on which the Central Bank or RBI borrows money from commercial banks within the country. It is a monetary policy instrument which is used to control the supply of funds in the country. An increase in reverse repo rate will decrease the demand of funds and other things remain constant. An increase in reverse repo rate increases the incentives of commercial banks to lend their amount to RBI and decrease the amount of supply in the market.
Following are the five major differences between repo and reverse repo rate to clearly explain the two different terms.
Both the above terms are opposite to each other in banking sector. Any increment in repo rates or reverse repo rates reflects the tightening of policies. The central Bank or RBI stands in an opposition in case of inflationary pressure.