The Reserve Bank of India determines the rate of borrowing and depositing funds for the commercial bank. These rates are known as repo rate and reverse repo rate is used to control the supply of money in the economy and control the inflation in the marketplace.
What is a Repo Rate?
Repo rate is the rate at which Reserve Bank of India provides funds to the commercial bank in times of financial needs. The commercial bank goes to the Reserve Bank of India when it falls short of funds to lend to the customers. Presently, the RBI repo rate stands at 4.40% with the 75 basis cut point in the previous repo rate of 5.15%.
Consider that SBI has taken Rs. 60,000 from the Reserve Bank of India at 5% repo rate. Then interest paid by SBI bank to RBI will be Rs. 3000.
What is Reverse Repo Rate?
Reverse repo rate is the rate at which commercial bank deposit funds with the Reserve Bank of India. When the commercial bank has excess funds, they can deposit the surplus funds lying with them. On collecting the money, RBI provides interest to the bank, which is decided by the RBI. Reserve Bank of India cut the reverse repo rate by 90 point basis to earlier rate. Presently, the reverse repo rate stands at 4%.
If SBI deposited Rs. 50,000 to the RBI AT 5% reverse repo rate, then the interest paid by RBI to State Bank of India will be Rs. 2500.
Repo Rate Vs Reverse Repo Rate: Key differences
- Liquidity: If the Reserve bank of India wants to reduce the liquidity in the market, then it will keep the repo rate high. It means that the RBI will charge a higher rate of interest to provide funds to the bank, which will ultimately drain the flow of cash in the economy. On the other hand, if RBI wants to increase the liquidity in the marketplace, it will keep the Reverse repo rate high. Maintaining a high reverse repo rate means the banks will deposit more money with the RBI, which will ultimately increase the flow of money in the market.
- RBI rate: RBI repo rate will always be higher than the rate at which commercial bank deposit funds with the Reserve Bank of India.
- Inflation: Reserve Bank of India uses the Repo Rate to control inflation in the economy. RBI increases the repo rate so that the commercial bank borrows less from the RBI. With the decrease in the supply of money in the marketplace, people will spend less money on purchasing. Thus, the demand for goods and services will decrease, which will ultimately control the inflation in the market. On the other hand, the reverse repo rate is used to manage the supply of money in the economy. It increases the reverse repo rate to reduce the money supply in the marketplace.
- Borrowing: Higher repo rate discourages the commercial bank from borrowing funds from RBI, and a higher reverse repo rate encourages the bank to deposit more money with the RBI.
- Managing the funds: When the Reserve Bank of India falls short of funds, it increases the reverse repo rate and on the other hand when there is an excess supply of cash in the marketplace it increases the repo rate.
|Point of difference||Repo Rate||Reverse Repo Rate|
|Liquidity||High repo rate to drain liquidity||High reverse repo rate to Inject liquidity|
|Borrowing||High repo rate discourages borrowing||High reverse repo rate encourages deposit|
|Purpose||High repo rate to control inflation||High reverse repo rate to increase money supply|
|Managing funds||Increases repo rate when there is an excess supply of cash.||Increases reverse repo rate when RBI fall short of funds|
Thus, with the increase in RBI’s repo rate, the money supply will decrease in the economy as the bank will borrow less from the RBI and on the other hand increasing the Reverse Repo rate also encourages banks to deposit money with the RBI, thus increasing the supply of money in the economy.
Read more: RBI Monetary Policy