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Tata Capital > Blog > Wealth Services > What is Repo Rate and Reverse Repo Rate?

Wealth Services

What is Repo Rate and Reverse Repo Rate?

What is Repo Rate and Reverse Repo Rate?

The repo rate and reverse repo rate are key concepts in banking and finance. The repo rate refers to the interest rate at which the central bank, the Reserve Bank of India, lends money to commercial banks, thereby impacting economic activity.

Conversely, the reverse repo rate is the interest rate at which the central bank borrows funds from commercial banks to manage market liquidity. These rates are vital tools the central bank uses to ensure economic stability.

In this article, we will explain the repo and reverse repo rates in detail and highlight the differences between them.

What is the repo rate?

The full form of ‘repo’ is ‘repurchasing option.’ This term refers to the rate at which commercial financial institutions can obtain last-minute funding from the RBI. In return, the RBI receives securities from these commercial institutions, including treasury bills, gold, or bonds.

Once the commercial institution has repaid its loan to the RBI, it has the option to repurchase these securities, hence, the term repurchasing option or repurchasing agreement.

What is the reverse repo rate?

The reverse repo rate is the interest rate at which the commercial banks lend money to the RBI. This monetary policy instrument is used to manage liquidity within the economy. When the RBI raises the reverse repo rate, it can withdraw excess liquidity from the banking system, helping reduce the inflationary pressure.

Repo Rate vs Reverse Repo Rate 

Now that what is repo rate and reverse repo rate are clear, let’s understand how they differ. 

The table below clarifies repo rate vs reverse repo rate:

FactorsRepo rateReverse repo rate
Purpose To inject liquidity into the banking system and meet short-term fund requirementsTo absorb excess liquidity from the banking system
Direction of TransactionMoney flows from RBI to commercial banksMoney flows from commercial banks to RBI
LenderReserve Bank of IndiaCommercial banks
Borrower Commercial banks Reserve Bank of India
CollateralBanks provide government securities to RBIRBI provides securities to banks
Impact of Higher RateMakes borrowing costlier for banks, leading to higher loan rates for consumers and reduced money supplyEncourages banks to park more funds with RBI, reducing lending and controlling inflation
Impact of Lower RateMakes borrowing cheaper, encouraging lending and spending, thereby boosting economic growthIncreases money supply as banks prefer lending over depositing with RBI
Effect on InflationHigher repo rate helps control inflation by reducing spendingHigher reverse repo rate helps control inflation by absorbing excess liquidity

What Factors Influence Changes in Repo and Reverse Repo Rate?

The Reserve Bank of India’s Monetary Policy Committee considers several factors before changing what is repo rate and reverse repo rates. 

These include:

Inflation levels: Track price rises to keep inflation close to the 4% target with ±2% tolerance.

Economic growth: Review GDP growth, industrial activity, and employment conditions.

Liquidity in the system: Check how much money is available in banks.

Global factors: Watch global interest rates, oil prices, currency movements, and capital flows.

Government finances: Consider government spending, borrowing, and budget position.

Supply-side conditions: Evaluate agricultural output, monsoon patterns, and supply chain issues.

Financial stability: Assess the health of banks, credit demand, and how well policy changes reach borrowers.

How Repo Rate and Reverse Repo Rate Impact Loans, Home Loans, EMIs & Savings

When the repo rate increases, lenders face higher borrowing costs from the RBI, leading them to raise interest rates on various types of loans, such as home loans, personal loans, and car loans. This results in higher EMIs for borrowers with floating-rate loans. 

Conversely, when the repo rate decreases, lenders reduce lending rates, lowering EMIs and making loans more affordable. 

For savings, higher repo rates encourage banks to offer better returns on fixed deposits and savings accounts to attract deposits, benefiting savers. However, lower repo rates reduce interest earned on these savings products. An important thing to note is that fixed-rate loans remain unaffected until their fixed period ends, while floating-rate loans adjust directly based on repo rate changes.

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FAQs

What is the difference between repo rate vs reverse repo rate?

The repo rate is the interest rate at which commercial banks borrow money from the RBI, while the reverse repo rate is the rate at which the RBI borrows money from commercial banks.

What is repo rate and reverse repo rate’s full form?

The full form of repo rate is Repurchase Agreement Rate or Repurchasing Option Rate. The reverse repo rate is simply called Reverse Repurchase Agreement Rate, representing the opposite transaction of the repo rate.

How do repo rate changes affect home loan EMIs?

When the repo rate increases, lenders raise home loan interest rates, leading to higher EMIs for floating-rate borrowers. Conversely, repo rate cuts reduce lending rates, resulting in lower EMIs and more affordable borrowing costs.

Why does RBI change repo rate vs reverse repo rate?

RBI changes repo rate vs reverse repo rates to control inflation, manage liquidity, support economic growth, and ensure financial stability in the country by influencing borrowing, spending, and saving in the economy.

Does reverse repo rate change always follow repo rate changes?

No. While repo and reverse repo rates often move together, RBI may change only one rate depending on liquidity conditions, inflation trends, and monetary policy objectives at that time.

How do repo rates vs reverse repo rates control inflation in India?

When the repo rate increases, borrowing becomes expensive, so lenders lend less and people spend less, which helps slow down rising prices. When the reverse repo rate increases, banks prefer parking money with RBI instead of lending, reducing money circulation and curbing inflation. 

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