The rate at which a central bank (RBI) lends money to a commercial bank (here SBI) is called the Repo Rate. Suppose you are the State Bank of India. You receive a proposal from a big business for a loan of Rs 1000 crore. The proposal is good, and you want to give them the loan. But due to recent losses, your liquidity isn’t as good- meaning that you have the amount, just not available for lending immediately- some of it is in advance out for other loans, etc. You have a loan demand of Rs 1000 crores, but you have only Rs 800 crore in your liquid assets. But the proposal is so good you can’t let it go. So what do you do, you go to your central bank- The Reserve Bank of India. You borrow some money (Rs 200 crore) from RBI in order to fulfill your short-term demand. Of course, RBI will not give you this money for free. It will charge interest from you for this loan that it is going to give you.

Repo Rate & Reverse Repo Rate

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I was sitting with my friend Shyam one fine evening when he stared at me for a long duration before asking,

You are a commerce graduate, right?

I said, Yes!

He replied, can you tell me what exactly is the difference between, Repo Rate and Reverse Repo Rate?

“My teammates often discuss it and I am standing clueless in front of them, nodding my head with hands in my pocket”.

Just like Shyam, many of us don’t get the two terms.

Google will also give you standard statements and not a thorough understanding of it and there is a long list of words in business newspapers that may not make sense to you.

The purpose of this article is to cover two such words- Repo Rate and Reverse Repo Rate.

We have all heard these words when the Reserve Bank of India (RBI) holds quarterly review meetings. We also hear them when policymakers justify certain economic decisions.

And we know that whenever these words are used frequently in newspapers and news channel discussions, our loan rates, and deposit rates are set to change- for better or worse.

So let’s pick these terms one by one and try to understand them. Just like I explained Shyam, I will keep it super simple for you to get a hold of the concept.

1. Repo Rate

What is Repo Rate?

Suppose you are the State Bank of India. You receive a proposal from a big business for a loan of Rs 1000 crore.

The proposal is good, and you want to give them the loan.

Loan demand is Rs 1000 crores, imagine you have only Rs 800 crore in your liquid assets due to recent losses.

But the proposal is so good you can’t let it go.

So what do you do?
You go to your central bank- The Reserve Bank of India. You borrow some money (Rs 200 crore) from RBI to fulfill your short-term demand.

Of course, RBI will charge interest from you for this loan that it is going to give you.

“The rate at which a central bank (RBI) lends money to a commercial bank (here SBI) is called the Repo Rate”.

2. Repo Rate – Repurchase Rate

Derived from the name itself, the “Repurchase rate” is the full form of the ‘Repo Rate’.

But, Why Repurchase?

RBI will not lend money to banks(SBI) without very particular security- (i.e.) Government bonds.

RBI enters into an agreement with the bank- that the bank will pledge the securities with RBI for the loan amount, and buy back at the future date at a pre-determined future price.

The Repo Rate here will determine how much more will the bank (SBI) pay to RBI for the same security while repurchasing them in the future.

3. Reverse Repo Rate

As you would have guessed, a Reverse Repo Rate is the opposite of a Repo Rate.

We discussed the scenario of Repo Rate with an example of SBI having no liquid money, now let us imagine a scenario where SBI has excess liquid money.

It means that the demand for loans is less, and the inflow of money in the form of savings is more for the bank.

Now, what will SBI do with the excess money?

It can invest somewhere, but investing in long-term plans might mean fewer liquid options for SBI.

So it parks the excess funds with RBI for the short term. Now, the rate of interest charged by the bank(SBI) is the Reverse Repo Rate.

“The rate at which a central bank parks money for a bank is called the Reverse Repo Rate”.

4. Repo Rate vs Reverse Repo Rate

Repo Rate	Reverse Repo Rate
Charged by RBI from banks	Charged by banks from RBI
Used to control inflation	Used to control the money supply
Always higher than Reverse Repo Rate	Always lower than Repo Rate

5. Repo Rate vs Bank Rate

The bank rate is very similar to Repo Rate, so please pay attention otherwise it can get confusing.

The bank rate is the rate that RBI charges from banks to borrow money from it.

Wait, that’s what Repo Rate was, right?

Well, yes and no.

Repo Rate, that is, Repurchase Rate focuses on buying back government securities from RBI at a pre-determined rate.

The key word here is Repurchasing. Government securities serve as collateral in this situation.

On the other hand, in the bank rate, there is no security with RBI as the focus here is on loans. That’s why you will find Repo Rate is slightly lower than the Bank rate.

(2023 August, Repo Rate – 6.50%, Bank Rate – 5.15%)

6. Impact Of Repo Rate On The Economy

Money market instruments include Repo Rates and Reverse Repo Rates. The central bank (RBI) uses these instruments to control the supply of money in the economy in order to meet its economic objectives.

Let’s imagine a situation.

Suppose the market is down. But you want to buy a house and the rate of interest is very high for you to afford.

a.) Lowering Repo Rate = Low-Interest Rate

RBI wants to solve this for you. It lowers the Repo Rate. Now banks can borrow any excess money they need, from RBI at a lower rate of interest.

Since they are getting money at a low rate of interest, they are able to lend it to you at a lower rate of interest as well.

Now you see the rate of interest has come down, and you can finally afford a house loan and its EMIs.

b.) Low Repo Rate = Increase Of Demand In Economy

How RBI uses Repo Rate to increase demand in the economy?

A lower rate of interest boosts spending by the people- since loan rates are low, they don’t hesitate to take credit to buy new things- cars, houses, even consumer goods.

c.) High Repo Rate = Decrease Of Demand In Economy

When there is an increase in inflation and driving up prices- RBI increases the Repo Rate. Now since banks’ cost of borrowing has increased, it will pass on the cost to you.

So the house you were happy to buy with a loan suddenly becomes difficult due to an increase in rate interest.

7. Repo Rate Q&A

i) What is the Current Repo Rate and Reverse Repo Rate in 2023?

The current Repo Rate in 2023 stands at 6.50% and the Current Reverse repo rate is at 3.35%.

ii) Why the difference between Repo Rate and the Reverse Repo Rate is always 1?

There used to be a stable difference of 1 % between both these rates since 2011, but that norm has been done away with. Now at present, there is a difference of only 25 basis points between the two rates.

FUN FACT:

The difference of 1 % was not mandatory but was announced as a rule in 2011 by RBI because of mainly two reasons

Reverse Repo Rate will be linked to Repo Rate and not announced separately
A fixed spread will ensure a clear policy message in the market

iii) Why Repo Rate is called a policy rate?

Repo Rate is often called a policy rate. That’s because it helps RBI achieve its monetary policy objectives- controlling inflation, increasing demand, etc.

iv) When does RBI increase Repo Rate?

If RBI feels there is too much money in the market and

Banks are lending too much
or People are buying too much

v) Why Reverse Repo Rate is less than Repo Rate?

Why Repo Rate is always higher than the Reverse Repo Rate?

The rates at which the RBI lends and borrows money are known as the repo rate and the reverse repo rate. And just like any bank, it will lend at a higher rate than the rate at which it borrows- in order to maintain a positive spread for itself.

Suppose you are a bank. You borrow from A and lend the same money to B. Now, in order to make money in these two transactions, you have to charge more money from B and pay less than that to A- simple business logic.

Here, what you pay to A is the Reverse Repo Rate, and what B pays you is Reverse Repo Rate.

vi) What is the relation between Repo Rate and Reverse Repo Rate?

The RBI employs the Repo Rate to keep inflation in check and the Reverse Repo Rate to regulate the flow of money. While the Repo Rate pumps liquidity into the market, the Reverse Repo Rate sucks it out.

It’s common for the Reverse Repo Rate to be set below the Repo Rate. This approach ensures a smooth balance, allowing the RBI to fine-tune economic stability with these two complementary tools.

vii) The Role of Reverse Repo Rate in controlling money supply: Explained!

He Reverse Repo Rate affects the money supply by incentivizing banks to either park their surplus funds with the central bank or lend them out. When the rate is raised, banks prefer parking funds, reducing lending and contracting the money supply.

Conversely, lowering the rate encourages lending, expanding the money supply. This tool helps central banks manage inflationary pressures by adjusting liquidity in the financial system.

viii) What is the RBI Repo Rate History?

Curious to see how Repo Rate changes have impacted borrowers and investors over the past two decades? Explore this insightful analysis from Holistic Investment: RBI Repo Rate History: Impact on Borrowers and Investors: https://www.holisticinvestment.in/rbi-repo-rate-history-2000-2024-impact-on-borrowers-and-investors/.

8. Summation

Next time you see your Home Loan Rate Of Interest increasing after an RBI policy review meeting, you will be in a better position to guess what rates they have tweaked, and in what direction.

So, what is your view on Repo Rate and Reverse Repo Rate? Have you understood the difference between the two?

Explained: What is Repo Rate and Reverse Repo?

Table of Contents:

1. Repo Rate