Repo Rate Vs Reverse Repo Rate

The latest repo rate, reverse repo rate, and other types of important rates of RBI are as follows:

Repo stands for ‘repurchasing option’. In India, RBI offers funds in exchange for securities to commercial banks that require urgent cash. The repo rate is the interest charged at the time of repurchase of the sold securities. This helps RBI regulate and curb inflation. 

Banks borrow money from the Reserve Bank of India to maintain their liquidity. In return, they must pay interest to the central bank. As part of the agreement, banks provide RBI with securities to back the loan. This agreement further carries a predetermined price to repurchase the securities. The interest payable during this repurchase is known as the repo rate. 

This rate fluctuates as per the policies of RBI and prevalent market conditions. The central bank’s Monetary Policy Committee (MPC) meets every three months to reflect on the need to increase or decrease the repo and other important rates. If no cuts or boosts are required, RBI’s MPC tends to keep these unchanged.

Cuts in repo rates allow commercial banks to get loans from RBI at lower interest rates, while a hike results in the exact opposite. The effects of changes in the repo rate trickle down to your personal finance as well. If it is lowered, your home loan might be impacted by a reduction in the interest you are liable to pay and vice versa.

RBI determines its lending rate after examining the state of the economy. If the rate of inflation is high, it means that the supply of money in the economy is higher than it should be. In this case, the repo rate is increased. This discourages people from borrowing, which reduces the overall supply of money, leading to a drop in inflation.

On the other hand, if the inflation rate is lower than what is considered healthy, RBI will reduce the repo rate. This makes it easier for banks to borrow more and increase the supply of money in the economy. With this move, the inflation rate is likely to reduce and stabilise.

A change in the repo rate has an instant effect on different industries. The revisions in the rate can be made for several reasons. These include:

• To control liquidity in the economy

• To control inflation

• To avoid the impact of geo-political tensions and recession

When there is a change in the repo rate, there will be a revision in your home loan EMIs as well. The instalment will change as per the reset date decided by the bank when offering the loan. According to RBI guidelines, the maximum reset frequency for repo rate-linked home loans is three months.

You might be wondering what a repurchase agreement is. A repurchase agreement refers to the agreement made by commercial banks to repurchase the securities sold to RBI when borrowing funds. 

Here are a few reasons why the repo rate and banks borrowing money from RBI under repurchase agreements are considered important:

• Controlling Economic Inflation: The repo rate is controlled based on economic inflation. It ensures that the inflation limit is always maintained.
  

• Short-Term Borrowing: The Reserve Bank of India offers liquid funds for a short period. At the end of the tenure, the banks buy the securities deposited previously, at a predetermined rate.
  

• Maintaining a Cash Reserve: The funds borrowed by commercial banks as per the repo rates, allow them to maintain a cash reserve at all times.

The repo rate is important to regulate the supply of money and the level of inflation within the country. The repo rate influences the cost of borrowing. When the repo rate is lower, the cost of borrowing is lower and vice-versa.

• Control of Inflation: When inflation increases, RBI implements strategies to control the cash flow within the economy. One of the methods to do this is by increasing the repo rate. This makes it difficult for businesses and industries to borrow money, hence, the flow of money in the market is controlled effectively. This helps in controlling inflation.

• Pumping Market Liquidity: RBI lowers the repo rate when it recognises the need to increase liquidity in the market. Cheaper repo rates enable businesses and industries to get more opportunities to borrow money. This leads to an increase in the supply of funds in the market, which boosts economic growth.

Let us understand the repo rate better by comparing it with two other prominent rates, which it is often confused with. Here are some differences between the repo rate, reverse repo rate, and MCLR.

You might be wondering that in the grand scheme of things, how does the repo rate affect your finances? Well, a repo rate affects your loan EMI payments. An increase in the repo rate can make your personal loan, home loan, and other loan EMIs, more expensive. Similarly, if it were to decrease, your monthly instalments are likely to become cheaper as well. 

The reason for this is that a bank decides your interest rate based on an MCLR as determined by RBI. When there is a fluctuation in the repo rate, the changes may be reflected in the MCLR as well, to help balance the overall economy. A change in the MCLR is likely to result in a change in your loan’s floating interest rate.

Additionally, when the repo rate is lowered, banks can potentially borrow more money at cheaper rates from RBI. This easy availability of funds increases the commercial banks’ lending ability, making loans cheaper.

Repo rate plays an essential role in maintaining cash flow, liquidity and stability in the overall economy. Furthermore, it also plays a vital role in your personal finances. The repayment of all types of loans, including home loans, can be impacted by a slight change in the repo rate. Therefore, it is essential to always have an eye out for any revisions made to this rate.