The rates at which the securities will be bought or sold are called REPO rates reverse REPO RATES.

The Repo rate mechanism is monetary tool used by RBI to enhance the Liquidity or absorb the excess Liquidity available in the money market so the resultant inflation or deflation can be brought to the envisaged level.

Liquidity is referred to the supply of the money.

When the supply of money is relatively high, then too much money will Chase too few goods which will result in inflation.

In the circumstances , the RBI would wish to suck the extra supply of money or the liquidity , by selling the government securities, so that to the extent of the Value of the securities the money will be taken back into RBI in its system from the circulation.

Similarly when the market is suffering from shortage of money which might have happened due to investments by public otherwise , the RBI would release the Liquidity or money by purchasing the securities from the open market so the supply money will be increased, so the Liquidity will be increased.

The above system of functions will normally found to be effective in the free market situations.

But the present situation is something different from the normal one . Every one has got the own share of impact out of the lockdown, from poor people to rich people.

Those who have borrowed and also who will get a cut in the income , due to the lockdown,will suffer very much. Those who had invested heavily out of borrowed funds also will find very much difficulty to compensate the loss of income but they have to pay interest for the borrowed fund for the lockdown period.

Every one has to share the burden to the extent possible- rich or poor -by sacrificing anything possible , to lift the economy to the , atleast, pre lockdown level first .

Most of our GDP or foreign exchange earned are from the exports to Europe countries and USA. To compensate the loss of foreign exchange which was used to import crude oil. It will take a very long time because most of the orders were cancelled and the payment are yet to be received.

Almost all the countries are at the same situation . So they have to come to a compromised situation so that the economies of various countries will emerge from the bottom.

Thanks for the A2 A. REPO Is an acronym . It stands for Repurchase Options.

In simple term Repo Rate is the rate at which Central Bank of a country(RBI in India ) provides short term loans to the Scheduled Commercial Banks and Scheduled Primary Urban Cooperative Banks . RBI does not provide loans to RRB (Regional Rural Banks), Payment Banks(e.g Airtel Payment Banks, Paytm Payment Banks etc ) or Small Finance Banks(e,g Au Small Finance Bank, Equitas Small Finance Bank etc.) under Repo.

Mind you under Repo RBI can provide loans up to one Year.

Repo Transaction are broadly divided into two types . One is called as Overnight Repo and other is called as Term Repo.

Overnight Repo: As the name suggest the lending period is 24 hours. It means if RBI provides loans under overnight repo to the banks then the banks has to repay it after 24 hours. What we popularly see in the newspaper about Repo rate , is actually Overnight Repo rate or in the words of RBI, POLICY REPO RATE. At present its is 6.25%

Reverse Repo Rate : It is opposite of Repo. In simple words when RBI accepts deposit from the Banks (as mentioned in repo case) for a short term duration it is called as Revere Repo rates. In many places ,reverse repo is defined as the rate at which RBI borrows from Banks for a short term period is called as reverse repo rate. RBI does not need money from banks hence it is referred to as deposits. Keep in Mind the duration of Reverse repo in India is of 24 hours.

Points to be noted .

Both in the case of Repo and reverse repo only specified Government securities(government bonds) are used as security.. It means when under repo RBI lends to the banks ,the banks has to keep government securities of appropriate value as security with RBI. Similarly in the case of Reverse Repo RBi is seen as a borrower hence it has to keep government securities of appropriate value as security with the Banks from which it is accepting deposits/money.

USE of Repo and Reverse Repo Rate

It is a monetary policy tool of RBI and it is used for monetary policy transmission by RBI.

What is Monetary policy?

It refers to the policy made by the Central bank of a country(RBI in India) to boost Economic development in the country and to control inflation.

Repo and Reverse repo is a tool of RBI to realize these objectives.

If RBI wants to boost economic development in the country ,it will encourage the banks to lend more to the public and Industry. For example if banks provides cheap loan to public to buy cars then the demand of cars will increase in India. To meet the demand of cars in India Maruti will set up a factory which will create employment , reduce poverty and in general will lead to the development of the country. So here RBI will reduce its Repo rate . The bank will get loan at cheaper rate and in theory banks will provide cheap loan to the public, So when the loan rates are affordable many ordinary people like us can dream to own a car by taking loan from the banks. It will kick start economic development in the country.

What about Reverse Repo rate ? RBI will reduce Reverse repo rate. Why?

Always remember banks work to earn profit. When RBI reduces Reverse Repo Rate it act as an disincentive for the banks . How? Suppose RBI reduce Reverser repo from 6%to 5.75%. Now if the banks lend their money to RBI under Reverse repo it will get only 5.75% while if it lends to maruti it will get at least 8%. Of Course when the banks lends to Maruti there is a risk. The company make go bankrupt and fails to repay its loans to the bank. Here banks thinks that demand for car is rising and maruti being a strong company its profit will rise in future as it ill be able to sell more cars. Hence the feature of maruti going bankrupt is very unlikely. So banks in order to earn more profit will not give money to RBI but to Maruti. This money will be used by Maruti to open an new factory thus creating new jobs etc.

To control inflation RBI wants the Banks to lend less in the market and consequently reduce demand in the market. How to achieve this?

It will increase both Repo and Reverse Repo. If it increases Repo rate then bank will get money at higher interest rate and to maintain there profit margin it will increase its lending rate. Loans will become costly for people and many people will drop the idea of borrowing from banks to buy maruti car. It will reduce the demand for car and at a certain point of time the demand for car will equal to supply of car thus price of the car will stop increasing and inflation will be under control.

Why Reverse Repo will be Increased? The logic is that RBI is 100% safe and there is never ever a fear that RBI will default but Maruti can. So to reduce the risk Banks will be tempted to deposit their money with RBI under reverse repo as there is no risk as compare to giving it to Maruti. When bank gives their money to RBI its lending ability declines correspondingly so lesser amount of money will reach the market, thus controlling inflation.

What is the repo rate and reserve repo rate ?

REPO rate is a monetary tool used by Reserve Bank of India to control inflation and thereby price stability. Normally the price depends on the supply of money in the system.

When the supply of money is more than required quantum in the sense to absorb the supply of goods in the market , then the price tend to rise. This is called inflation.

The primary responsibility of RBI is Keep under control the inflation. The supply side of goods depends more on many factors. However the inflation has to be controlled so that RBI is using the tool to manipulate the increase or absorb the money in circulation as it is needed.

REPO is repurchase and therefore repo rate is the rate at which the securities will be repurchased by RBI. Hence the reverse repo is the rate at which RBI will give back the securities repurchased to the commercial banks.

REPO is referred as Re Po repossession of the securities.

When the supply of money is in excess RBI starts to release the securities possessed to commercial banks so that the supply of money will reduce . Hence the price will be stabilized.

Similarly when the price of goods starts falling as there is not enough money to absorb the supply of goods RBI will start repossession of the securities from commercial banks so that the supply of money is increased and the price stability is attained.

The rate is getting importance because it attracts the bank when the rate is comparatively cheap.

Hypothetical example. The commercial banks are raising short time deposits at 5% to meet their requirements and the cost is loaded in the rate of interest charged to the customers.

At this situation if the repo rate , the rate at which RBI is lending , is 3% the commercial banks will approach RBI to get the needed money and the difference in the cost of getting the money is passed on to the customers. In other words the customers will stand to get cheaper credit so that it will lead to economic development.

Ultimately the short term deposit interest rate at which the deposit is accepted will be reduced by commercial banks as they are able to get from RBI. These are theoretically accepted principles.

Credit and monetary policy : - The policy by which the desired level of money flow and its demand is regulated is known as the credit and monetary policy.

All over the world it is announced by the central banking body of the country.

RBI uses many instruments/tools to put in place the required kind of credit and monetary policy such as - CRR,SLR,Bank rate,Repo rate , Reverse rate,MSF rate etc. On which it has regulatory controls.

1. Bank rate :- The interest rate which the RBI charges on its long-term landings is known as the Bank rate. The client who borrow trough this route are the government of India,state government,banks, financial institutions,co-operative banks,NBFC etc.
2. Repo rate(1992) :- The rate of interest the RBI charges from its clients on their short- term borrowing is the repo rate in India.
3. Reverse rate(1996) :- This rate of interest the RBI pays to its clients who offer short-term loan to it is reverse rate.

All banks and commercial lenders borrow money from the Reserve Bank of India. The rate of interest that the RBI charges when a bank or a commercial lender borrows money from it under normal circumstances is known as the Bank Rate. However, there is a limit to which lenders can borrow money from the central bank of the country at the Bank Rate. When a bank exhausts this limit, it can borrow money from the Reserve Bank of India by pledging government securities that it owns, such as gold, cash and government-approved bonds. When a bank or a commercial lender borrows against these securities, the rate of interest that the RBI charges is known as the Repo Rate.

The Repo Rate is one of the monetary policy tools that the RBI uses to control inflation and keep the growth of the Indian economy on track and it does so by changing the Repo Rate every three months. The RBI publishes these changes on its website. The Bank Rate is always lower than the Repo Rate. The current bank rate is 5.15% and the current Repo Rate is 6.50% per annum. The last time the Reserve Bank of India changed the Repo Rate was on June 8, 2023. Back then, the RBI had increased the Repo Rate by 25 bps to 6.50% per annum. Since then, the RBI has kept the Repo Rate unchanged at 6.50% per annum.

So, why does the RBI change the Repo Rate and how does it affect the common man? When inflation within the Indian economy goes beyond an acceptable level and prices of commodities shoot too high. the RBI increases the Repo Rate. When the RBI increases the Repo Rate, loans become expensive and people borrow less. Thus, when the RBI increases the Repo Rate, the circulation of money within the Indian economy goes down and therefore, the prices of things automatically go down. On the other hand, when the RBI decreases the Repo Rate, loans become cheaper, which in turn, increases the flow of money within the Indian economy and gives it a boost as well. For the common man, the ideal time to borrow money is when the Repo Rate is low. Further, floating interest rate loans get directly impacted by changes in the Repo Rate and therefore, individuals repaying a loan on floating interest rates must keep an eye on Repo Rate changes.

Definition of Repo Rate

Repurchase Option or a Repo rate is the rate at which the Reserve Bank of India (RBI) grants the loan to the commercial banks against government securities. It is charged on Repurchase Agreement i.e. an agreement between two parties in which one party sells its securities to another promising that the securities would be bought back over a specified period.

For controlling the inflation, RBI uses this tool whereby the rate is increased to reduce the commercial bank’s borrowings, which in return pulls down the inflation. As on 29 August 2018, Policy repo rate is 6.50%.

Definition of Reverse Repo Rate

Reverse repo rate is exactly opposite to a Repo rate; it is an interest rate at which the commercial bank grants the loan to the Central Bank of India i.e. RBI. The Reverse repo rate is always lower than a repo rate.

This is a monetary tool used by RBI to control the money supply in the country, i.e. with the increase in the rate, the flow of money in the economy decreases as the banks will now invest its money with RBI due to safety and lucrative interest rates. As on 29 August 2018 the Reverse repo rate is 6.25%.

The Governor of The Reserve Bank of India, Mr. Shaktikanta Das addressed media for the second time during the lock-down period. Assessing the current economic situation, Mr. Das said that the RBI is monitoring and taking each and every measure to address and face the daunting challenges posed by the pandemic. He emphasized on doing 'whatever it takes' to prevent the epidemiological curve from steepening any further. The main focus was on increasing the liquidity in the markets and smoothing the deteriorated economy due to the Novel Corona Virus.

Following are the measures introduced by the Governor:

1) Liquidity Adjustment Facility

Fixed Rate Reverse Repo Rate The RBI has reduce the fixed rate reverse repo rate under the liquidity adjustment facility by 25 bps from 4.0 per cent to 3.75 per cent. which will force banks to deploy its fund in other sectors at higher returns rather than in RBI for smooth functioning of funds in the market. (RBI did not focus on reducing the Repo Rate. Lowering the rate would have resulted in another measure for increasing liquidity in the market.)

2) Targeted Long Term Repo Operations (TLTRO) 2.0 :

The RBI on March 27, introduced the Targeted Long Term Repo Operations (TLTROs) as a tool to enhance liquidity in the market, in the wake of the Corona Virus crisis amounting to ₹100,000 crore. The RBI observed that the deployment of TLTRO funds have largely been to bonds issued by public sector entities and large corporates. The disruptions caused by the pandemic has, however, more severely impacted small and mid-sized corporates, including non-banking financial companies (NBFCs) and micro finance institutions (MFIs), in terms of access to liquidity. Accordingly, it further decided to conduct targeted long-term repo operations (TLTRO 2.0) for an aggregate amount of ₹50,000 crore. with at least 50 per cent of the total amount availed going to small and mid-sized NBFCs and MFIs. These investments have to be made within one month of the av-ailment of liquidity from the RBI. (If the banks fail to deploy such funds within one month than the Repo Rate increases by 200bps for the number of days such funds remain un-deployed. This incremental interest will have to be paid along with regular interest at the time of maturity. This makes pressure on the banks and even fulfill the objective of *lending, lending and lending* by the commercial banks in order to save costs.)

3) Refinancing Facilities for All India Financial Institutions (AIFIs)

All India financial institutions (AIFIs) such as the National Bank for Agriculture and Rural Development (NABARD), the Small Industries Development Bank of India (SIDBI) and the National Housing Bank (NHB) are facing difficulties in raising funds from the market. Accordingly, RBI decided to open doors for provide special refinance facilities for a total amount of ₹50,000 crore to NABARD, SIDBI and NHB to enable them to meet sectoral credit needs.This will comprise ₹25,000 crore to NABARD which will help them for refinancing regional rural banks, cooperative banks and micro finance institutions; ₹15,000 crore to SIDBI for lending and refinancing; and ₹ 10,000 crore to NHB for supporting housing finance companies (HFCs).

4) Ways and Means Advances for States

On April 1, 2020 the RBI had announced an increase in the ways and means advances (WMA) limit of states by 30 per cent. It further decided to increase the WMA limit of states by 60 per cent over and above the level as on March 31, 2020. The purpose was to provide greater comfort to the states for undertaking COVID-19 containment and mitigation efforts, and to plan their market borrowing programmes because the current situation of lockdown has resulted in revenue reducing, as there has been a standstill in the cash inflow from petroleum products, GST, liquor, real estate, motor vehicles, stamp duty etc.

5) Non Performing Asset Classification

Banks classify accounts as standard, substandard and doubtful, based on the number of days their payments are delayed. Borrowers turn non-performing only after 90 days of overdue and are classified as standard prior to that, notwithstanding any delay in repayments. The RBI has decided to provide an asset classification pause for standard accounts that avail a moratorium between 1 March and 31 May.

In simple terms, it means that the bad loan classification period has changed to 180 days from 90 days. With the objective of ensuring that banks maintain sufficient funds and remain adequately provisioned to meet future challenges, they will have to maintain higher provision of 10 per cent on all such accounts under the pause, spread over two quarters (March, 2020 and June, 2020.)

6) Distribution of Dividend

In the period of stress in the economy, it is obvious that banks conserve capital to retain their capacity to support the economy and absorb losses in an environment of uncertainty. Therefore, RBI has given relaxation to scheduled commercial banks and cooperative banks. No further dividend payouts from profits pertaining to the financial year ended March 31, 2020 shall be made until further instructions.This restriction will be reviewed on the basis of the financial position of banks for the Quarter-2 2020.

7) Liquidity Coverage Ratio

As the Central bank seems to be much concerned about the liquidity, it brought down the LCR requirement for Scheduled Commercial Banks from 100 per cent to 80 per cent with immediate effect. In simple terms, the financial stress faced due to the pandemic can cause banks to use their HQLA (High Quality Liquid Assests), which can lead to LCR falling down below 100 per cent. The requirement shall be gradually restored back in two phases: 90 per cent by October 1, 2020 and 100 per cent by April 1, 2021.

Conclusion: The RBI has taken various steps for increasing the liquidity in the market. The Reserve Bank has also geared Rs 1.2 lakh crore of fresh currency into the system in last 45 days since the Novel Corona Virus outbreak in the country. In my opinion, it should have also focused on reducing the Repo Rate which would have encouraged banks to avail more funds from the RBI.

Thank you.

Banks in India are regulated by RBI and it is RBI which decides these rates which are called policy rates.

To understand these rates we just need to think a little of Banking Business. A Bank is an institution which accepts deposits for the purpose of lending. ( this is a classical definition as Banks have expanded their business portfolio to several other fields). Since a Bank needs money for its lending business it can be obtained by increasing deposits which in short term is not possible as deposits are made by customer over a period of time and not instant at demand of bank, so the other option available for banks is to borrow money to meet its immediate needs. The money is also required for keeping a part of its deposits with RBI for various reserve ratio as made mandatory by RBI and any change in these ratios changes the amount of money deposited with RBI.

Thus to meet its demands as mentioned the Banks borrow money from the Biggest lender which happens to be RBI. And like any other lender RBI lends money at a cost (in normal language interest) by keeping some collateral in form of governments bonds/ securities to the banks for a short term ranging up to a fortnight. “This rate at which Banks borrow money for short term from RBI is called a Repo Rate”. The Repo here means repurchase option as the money which has been borrowed, is done by keeping securities with RBI which banks have to repurchase after expiry of loan term.

In case of Reverse Repo the opposite happens. When Banks have excess funds and are not able to lend immediately they tend to park these funds again with RBI so that they can earn some interest on these funds. The rate at which these funds are parked with RBI is reverse repo and it is always less than the Repo for simple reason as RBI will never pay more money on deposits than what it charges for lending money.

Both the rates are short term and are used very frequently by Banks and these rates decide the overall interest rate charged by banks to the public as these rates determine the cost of funds available to the Banks.

Bank Rate is the rate charged by central bank of the country which is RBI , for extending loans to commercial banks. Please note that there is no repurchase agreement of securities under Bank Rate and this is how it differs from Repo Rate. Bank Rate is usually higher than the repo rate as this is the benchmark of general interest rates in the country as no one can lend money below this rate.

When a commercial bank goes through financial crisis, they approach RBI. The interest at which banks borrow 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: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. Repo rate in India is fixed and monitored by India’s central banking institution, the Reserve Bank of India. It proves beneficial for short-term financial crisis. It is one of the powerful tools used by the central bank to control liquidity, money supply and inflation level in the country.

What is a Repo Rate?

A ‘repo’ is nothing but a ‘repurchase agreement’. Even normal individuals can enter in a repo agreement. I give you a signed piece of paper in exchange for Rs. 10k. The paper states that “I will repurchase the signed piece of paper from you at a given date in the future for Rs. 11k.” The Rs. 1k or 10% is the ‘Repo Rate’. In the case of repo agreements between a central bank and commercial banks, the piece of paper is called the ‘Repo Rate Agreement’.

Why does the central bank do this?

Because a central bank needs to control the ‘cash in the system’, so to say. That’s in their job description. In order to do that, they usually put up a handful of rules, the primary being the reserve requirements for banks and the ‘repo’ rates.

What are the reserve requirements?

In India, the RBI has told the banks that they need to have a CRR (Cash Reserve Ratio) of 4% and a SLR (Statutory Liquidity Ratio) of 21%. This simply means that for every Rs. 100 that a bank has in its hands, it needs to give for safe-keeping Rs. 4 in hot cash and Rs. 21 as either cash and/or investment in government bonds to the RBI. This Rs. 25 acts as a guarantee of sorts in case the bank collapses.

Where does Repo figure in this?

Let’s suppose that a bank has only received Rs. 100 worth of deposits. The bank gives the RBI Rs. 25 by way of maintaining the CRR and SLR. Slowly, the bank lends out the remaining Rs. 75 to its customers.

Now, the bank figures out that there is still some demand for loans. It’s out of money though. So the bank tells the RBI “Hey, lend me Rs. 50. I’ll give you back Rs. 12.5 by way of CRR and SLR. Let me utilize the remaining Rs. 37.50 for my business.” Remember, the RBI prints money. The RBI can never run out of money to lend, unlike the banks.

The RBI replies “Fine, take this Rs. 50. But for your SLR requirements, you will have to purchase government bonds from me. So, at a given date in the future, you will repurchase your agreement from me at Rs. 50 plus 6.50% interest per annum and I will repurchase my government bonds from you at 6.00% per annum.”

The first part of the agreement, where the bank repurchases its agreement from the RBI is called the Repo Agreement. The second part of the agreement, where the RBI repurchases its government bonds from the bank is called the Reverse Repo Agreement. You might have noticed that the Reverse Repo Rate is always lesser than the Repo Rate. That’s one of the perks of being the controller of the banking system of the country.

The central bank and the commercial banks engage in these repo transactions (Called ‘Repo Rate Auctions’) very often. The repo is basically how money flows from the central bank to the banks and into the system.

Why does the Repo Rate matter so much?

So, we’ve seen how a repo works, both generally and in the banking system. But why does the 6.50% matter so much? Every two months, the RBI does a policy review. The most important part of it is the modification of ‘key rates’ (Repo, CRR, SLR, MSF).

Indian banks are currently ‘borrowing’ from the RBI at 6.50%. Imagine that the RBI announces a 50 Basis Points ‘rate cut’. The 6.50% drops to 6.00%. The banks can now borrow more and pay lesser interest to the RBI. Higher cash in the hands of the bank will mean higher lending from the banks to the public. Higher cash in the hands of the public means more spending on goods and services. More spending and demand leads to inflation - or rise in prices of goods and services. The public starts suffering from inflation.

The RBI now intervenes and increases the Repo Rate, to say 7.25%. Now, the banks can borrow only lesser and pay a higher interest rate on it as well. You can probably fill in the gaps of what will happen next based on what we saw above. This gradually leads to a recession. The RBI again intervenes and ‘cuts’ the rate, again.

It’s a vicious cycle and a cycle which needs to be monitored closely. Ineffective monetary policy will lead to depression, hyper-inflation and all sorts of economic anomalies. Although the Repo Rate is not the only weapon at the disposal of a central bank, it’s the quickest and deadliest.

Alice Rivlin, the former Vice-Chair of the U.S. Federal Reserve puts it in a nutshell: “The job of the Central Bank is to worry.”

Repo rate is the rate at which RBI lends money to commercial banks. The higher the repo rate the lesser the banks will borrow from RBI thereby reducing liquidity in the market and vice-versa.

Reverse repo rate is the rate at which RBI borrows from the commercial banks. The higher the reverse repo rate the more commercial banks will park their money in RBI thereby reducing the liquidity in the market and vice-versa.

Since RBI is a very secure institution, banks will prefer parking their money in RBI rather than giving loans to businesses and individuals.
Reverse repo rate is not kept high in order to avoid this scenario. This will ensure that the commercial banks will have sufficient funds to invest elsewhere or use as liquidity thereby increasing the buying capacity of the people.

Reverse repo rate is always lesser than repo rate so that the flow of money should be there from RBI to commercial banks. RBI doesn't want to keep all the money. The commercial banks and businesses need the money so that the economy has enough purchasing power.

When commercial banks are in short of funds, they approach the central bank of the country, i.e., RBI for financial assistance.

Repo Rate is the rate at which RBI lends money to commercial banks during a financial crisis. In other words, commercial banks borrow funds from Reserve Bank of India by selling their securities or bonds with an agreement to repurchase the same on a later date. The rate of interest charged by RBI on the cash borrowed by the commercial banks is called the “Repo Rate”.

For example: if the Repo Rate is 10% and the loan amount borrowed by a commercial bank from RBI is Rs.10,00,000, the interest paid to the RBI will be Rs.1,000.

On the contrary, when a commercial bank has excess funds, they can deposit the same in central bank and earn “Reverse Repo Rate” interest. For example: if the Repo Rate is 10% and the funds deposited by the commercial bank to the RBI account is Rs.10,000 then the interest paid to the commercial bank by RBI is Rs.1,00,000.

Repo Rate also determines the liquidity rate in the banking system. If RBI wants to increase the liquidity rate, then it will reduce the Repo Rate thereby encouraging the banks to sell their securities. On the other hand, if the central bank wants to control liquidity, it will then increase the interest rate, discouraging banks to borrow. An increased Repo Rate will fetch the central bank a higher interest rate from the commercial banks, while an increased Reverse Repo Rate increases the returns of the commercial banks through high interest from the central bank.

Reverse Repo Rate : Reverse Repo rate is just opposite of repo rate and means the rate at which RBI borrows funds from the banks.

If RBI increases this rate, the banks will get higher rate of returns by lending money to RBI.

Cash Reserve Ratio (CRR): Commercial banks have to maintain a certain percentage deposits in cash, out of the incremental deposits received by banks. This ratio is called Cash Reserve Ratio (CRR).

A decrease in the rate of CRR will force the Banks to lend more money as banks will be flush with funds. This means, more lending will encourage more economic activities and may also generate employment opportunities. Alternatively, when RBI increases the CRR, the excessive money with the banking system will be sucked into the economy, thereby reducing the lending activity of banks. These are the basic policy rates, which are very crucial for the economy.

Bank rate, or Discount rate : is the rate at which the RBI provides loans to commercial banks. When RBI increases the bank rate, the cost of borrowing funds for the commercial banks will become expensive, leading to a decline in the volume of credit. This measure is used to tighten the economy.

Repo Rate is a short-term measure used to control the amount of money in the market. Bank rate, on the other hand, is a long-term measure governed by the long-term monetary policy of the RBI. This tool is used by the RBI to control the money supply in the economy. DR. M.J. SUBRAMANYAM

RBI acts as the Banker's Bank and it controls Banks through RBI Act 1934 and Banking Regulation Act 1949. The Monetary Policy Committee (MPC) revise Repo and Reverse Repo Rates once in every two months.

RBI lends to Banks at Repo Rate against government securities. Banks keep their surplus fund beyond CRR threshold at Reverse Repo Rate. The borrowers lending rates are decided on the basis of Repo Rate as lending rates are linked to it.

Banks decide deposit interest rates on the basis of lending rates. They earn a margin of profit out of interest earned and interest paid for their operational expenses. Thus repo and reverse rates play an important role in regulating money supply in the country through bank credit.

Bank rate : The rate of interest at which the central bank of a country lends money to the commercial banks of that country to meet the shortfall of funds without any buying or selling of securities.

Repo rate: The rate at which commercial banks borrow funds from central bank when they have shortage of funds by selling securities to the central bank with an agreement to buy back those securities at a predetermined rate and date.

Reverse Repo rate: The rate at which commercial banks deposit their surplus funds with the central bank for a short period when they have no lending or investment option. Thus they earn interest on these funds.

Thanks

Before we understand how the repo rate and reverse repo rate affects the financial economy, let us look at what the repo rate and reverse repo rate actually do.

What is the Repo and Reverse Repo?

The following diagram helps succinctly explain the actual function of the repo rate ([math]R_{s}[/math]) and the reverse repo rate ([math]R_{d}[/math]).

It is illuminating to look at money circulating in the money markets as a supply and demand that is determined by the repo rate and the reverse repo rate. The repo rate is the rate at which the RBI decides to supply liquidity (or money) into the system, i.e. the rate at which RBI lends to banks. As you know that supply curves are are upward sloping, greater supply is given at a higher rate (just like price). As the rate is fixed, it is a step function. Just like the repo rate, the reverse repo rate at which the RBI demands liquidity, i.e. the rate at which banks can lend to the RBI.

(Courtesy : Macroeconomics, D'Souza)

As you can see, the intersection of the demand and supply curves, coupled with NBR (Non borrowed reserves or reserves with the RBI), determines the interbank rate i.e. the rate at which banks lend to each other. Nobody will be willing to borrow at a higher rate than what they can get from the RBI or lend at a rate lower than the rate at which they can lend to the RBI.

The interbank rate is critical in understanding how it affects the money economy. The RBI through the repo, reverse repo and NBR try to fix the interbank rate. Of course, the estimate of the demand function by the RBI may not be the actual demand function and the actual interbank rate may be different from what the RBI expects. Better teams are able to predict better, and this is essentially how interest rates (or interbank rates) are set by the RBI. Cutting rates is essentially lowering this rate through the reverse repo, repo and NBR. As you can see, it requires a lot of research and estimation.

How does interest rate setting affect the economy?

Banks are able to lend to each other at the interbank rate, and these help in setting interest rates. As you would have seen a lot of keynotes by Dr. Rajan, interest rates need to be transmitted, and it takes time for banks to adjust their rates on the basis of the interbank rate.

These interest rates are the basis for setting loan and deposit rates for banks, and people can borrow or deposit at these rates. It allows you and I to borrow, deposit, spend more easily/with greater difficulty. Yields for bonds and other debt instruments are also affected by these. Banks set their interest rates above the interbank rate, primarily because they generate income through loans which finance their operations. Banks should have some difference between the rate in which they can borrow (costs) and which they can lend (revenue), which is why it is above the interbank rate.

Lower interest rates can make it easy to borrow and hence "infuses" money in the system. The flipside is that it can increase inflation, because people can now purchase more with more money in the system,which is what Dr. Rajan is cautious about.

Does Monetary Policy affect the real economy in the long run?

Keynes says that monetary policy is ineffective in the long run (he also says that people are dead in the long run, but anyway). Whether it is effective or not merits another entire post, or even books. Nevertheless, it's effective management is key to a stable financial system.

• The Repo Rate, Reverse Repo Rate, Marginal Standing Facility rate and bank rate are called 'Policy Rates'. CRR and SLR are called "Reserve Ratios".

• Previously all policy rates were announced differently through RBI. However, from May 3, 2011, only repo rates are announced. Reverse repo rates and MSF rates are linked to repo rates, while bank rates are linked to MSF rates. How much lower or higher the other rates are than the repo rate is announced from time to time by the RBI.

• Currently (January 2019) the reverse repo rate is 0.25% less than the repo rate, While the MSF rate is 0.25% higher than the repo rate. The bank rate is the same as the MSF rate.

• Current (July 2019) Policy Rate:
Repo rate: 5.75%
Reverse repo rate: 5.50%

MSF: 6.00%
Bank rate: 6.00%

• Current (January 2019) reserve ratio:

CRR: 4.0%
SLR: 18.75%

Bank managers has to make sure they must maintain certain liquidity every day end before they leave office or shutter down. If a bank doesn't have this liquidity, the ascertained liquidity can be borrowed from the overnight window, discount window or repo window as they are termed of the Central Bank. The rate charged at this window is called the repo rate.

If you have excess beyond the statutory liquidity level, one can deposit at discount window and they pay at an interest rate for what is deposited, which is the reverse repo rate.

When credit demand is high, repo tend to rise and vice versa, signalling an expanding and contracting status of the economy.

The RBI can influence the availability of credit in the commercial banks through repo and reverse repo rates.

Reverse Repo rate is the rate at which the RBI borrows money from commercial banks. In other words, Reverse Repo rate is the rate of interest offered by RBI to banks, when banks deposit their surplus funds with the RBI for a short period of time.

When banks are flush with funds and have no other profitable lending avenues or investment options, they choose to deposit the excess money with RBI, which is more safe than lending it to their borrowers or other companies. Further, such surplus funds parked with RBI earn interest for the banks, besides ensuring safety of funds. ( No question of becoming NPAs). This also provides an opportunity for commercial banks and other leading financial institutions to make quick profits within a short period of time.

Reverse repo rate is, thus, a monetary policy instrument used by the RBI to control the supply of money in the country.

Impact on Inflation:

An increase in reverse repo rate prompts banks to park more funds to RBI. Consequent on this, their cash base gets reduced, adversely affecting their capacity to lend money to business. As a result, banks start charging higher rate of interest on their loans. Due to this, the customers are dissuaded from borrowing funds from banks, resulting in shortage of money in the economy and less production and expansion of business. At the same time, there will be increase in the interest rate on the deposits to attract more deposits from the depositors.

During such periods, many sectors such as consumer durable, automobiles, and others become most vulnerable pushing the rates upwards and reducing the demand for such products. In addition to this, the earnings of these sectors also get affected owing to increase in interest costs. Besides, more money is pumped to debt than equities given the risk-return trade offs.

On other hand, when the repo rate is reduced, fund-base with the banks increases, which enables the banks to expand their credit. Then banks will start charging lower rates of interest on the loans. This encourage the demand for more goods resulting in increase in GDP. DR. M.J. SUBRAMANYAM

Repo rate is the rate at which the Central Bank like RBI lends money to the commercial banks. On the other hand, reverse Repo rate is the rate at which the commercial banks lend money to the RBI.

If the Repo rate is high, it will mean that the commercial banks will be getting money at a high cost which in turn will make the loans to the common public costly too and will help the RBI to contract the money supply.

If the reverse repo rate is high, it will decrease the money supply as the commercial banks will simply give the money to RBI which in turn will leave the banks with less money available to lend to the common public as loans.

Foreign exchange reserves refer to the assets denominated in a foreign currency held by a central bank for meeting the liabilities of the country. The foreign exchange reserves influence the country's monetary policy.

Foreign exchange reserves can include deposits, bonds, treasury bills, and other government securities. Economists suggest that it’s always good to hold foreign exchange reserves - the assets in a currency that is not directly connected to the country’s own currency.

Most of the reserves by almost all the countries are held in the U.S. dollar since it is the most traded currency in the world economy . In fact major amount is held in USD and all the countries do prefer to hold the foreign exchange reserves in British pound (GBP), the euro (EUR), the Chinese yuan (CNY) or the Japanese yen (JPY) too.

The world's largest current foreign exchange reserve holder is China which is holding more than USD 3. 6 trillion of its assets in a foreign currency. As said earlier , most of its reserves are held in the U.S. dollar. As of May 2024, China holds USD 768.3 billion in U.S. Treasury securities being the second-largest foreign exchange holder of U.S. debt whereas Japan is holding highest USD treasury securities for USD 1.3 trillion. Switzerland holds USD 890 billion.

Saudi Arabia also holds considerable foreign exchange reserves, as the country relies mainly on the export of its vast oil reserves. If oil prices begin to fall heavily, the economy would suffer very much. Large amounts of foreign funds will act as a cushion against such shock.

As the international trade is carried out in USD mostly, the countries find easier to execute the trades and settlement .

U.S. foreign exchange reserves are held to the tune of USD 244 billion as of the last week of July 2024.

Russia’s foreign exchange reserves too are held mostly in U.S. dollars, like the rest of the world. But the country also keeps some of its reserves in gold as USA may suddenly impose sanction on Russia. As of February 2022, Russia's foreign exchange reserves was about USD 630 billion. On account of sanctions imposed by the European Union (EU), the U.S., and other nations on account of Russia's invasion of Ukraine in February 2022 , most of the fex reserves had become inaccessible.

There is a danger of using gold as a foreign exchange reserves is that the asset is only worthy if there is any buyer and capability of paying for gold.

India’s forex reserves is USD 701,176 trillion as of September 2024.

The MPC of RBI has increased the Repo rate by 50 bps to 4.9% with immediate effect. The RBI also raised the standing deposit facility by 50 bps to 465% and the marginal standing facility by 50 bps to 5.15%. This is the second gike for the year, after the off cycle meet last month. The recent hikes in the interest rates are induced by the rampant implation which is haunting the Indian consumer class. RBI also bumped up its inflation projection from 5.7% to 6.7%.

For an economy the Banks are regulated by a central bank. This involves out of many things, regulating interest rates prevailing in the economy a signal for all economic players regarding the direction of the economy and on which how the players need to reposition themselves according to this signals manifestation. The players include banks, companies, investors, savers etc;. So this rate is called the repo rate or repositioning rate in full form. This is the interest asked by the central bank for borrowing by banks for liquidity maintainence.

On the other hand, if the banks have excess funds, they can park it with the central bank for which the central bank pays interest. This is also a policy rate a nd is called the reverse repo rate.

The reverse repo is always lesser than repo. I think the reason for this is obvious. In some rare states of economy the repo is kept lesser than reverse repo.This is to control and regulate the credit flow in the economy, so that the economic expansion won't get out of hand to produce instabilities in the nation.

Repo rate

• It is the rate at which commercial bank borrow funds from the public to meet emergent needs against the security of government securities
• This is a short term loan
• The loan may be for a day or two days
• At present the rate is 6.25 percent p.a.
• When REPO rate is increased, banks are compelled to pay interest for such increase and in order to meet such increase, they have to increase their income. This prompts them to borrow less funds from RBI and they are left with less money than their requirements. When they have less money, they lend less and on account of this reduced lending, there is liqudity crunch in the economy
• At the time of inflation, RBI increases repo rate so that the amount available with the public is reduced through commerical banks and now they tend to spend less and automatically the prices stabilsie and they settle at standard rates

Reverse repo

• This is the rate at which commercial banks park their excess funds with RBI
• This is like a deposit or an investment made by the banks with RBI
• The rate is 50 basis points below Repo and presently it is 5.75 percent
• It means that for the amount invested by commercial banks with RBI they earn an interest at 5.75 % p.a.
• Normally banks are eager to use this facility
• Because, the amount is safe in the hands of RBI
• The entire amount is repaid along with interest without any difficulty by RBI
• Unlike loans, there is no question of non performing assets
• RBI will never increase reverse repo rate and this rate is linked to repo rate by some basis points and as and when there is a change in REP O rate, to that extent, there will be change in reverse repo rate also