Reverse repo rate, along with repo rate, forms one of the most important monetary tools that is put into effect by the central bank (RBI) to regulate inflation and liquidity in an economy.
What is Reverse Repo Rate?
Reverse repo rate is said to be that rate of interest at which a central bank (RBI in India) borrows money from commercial banks for a short term. It helps the central bank to have a ready source of liquidity at the time of need. RBI offers great interest rates in return for the amount supplied by the commercial banks.
Commercial banks also keep the excess funds that they receive with RBI as it is considered safe. The added benefit is that RBI will also pay interest, which gives the banks an option to earn interest on their idle money.
Reverse Repo Rate and money flow
When there is an increase in the reverse repo rate, it allows commercial banks to push their additional funds into the safe custody of the RBI for a short term and also earn attractive interests for the same. This step brings about a reduction in the liquidity of the banks.
RBI accepts the excess money from banks by providing government securities as collateral. This is facilitated using LAF (Liquidity Adjustment Facility)
Also Check: What is Repo Rate?
Impact of Reverse Repo Rate on Economy
Reverse repo rate has an impact on the economy as when the reverse repo rate is increased banks deposit their surplus funds with RBI in order to gain interest.
The result is that the economy experiences reduced money flow, the banks find it more feasible to deposit the money in the central bank rather than providing it to individuals or businesses which results in boosting the value of the rupee.
Similarly, inflation is controlled by RBI by increasing the reverse repo rate, and when the situations are perfect for increasing the inflation, RBI then cuts the reverse repo rate and repo rate so as to inject liquidity in the economy.
The impact of change in reverse repo rate can be seen in home loans, as an increased reverse repo rate will encourage banks to invest their surplus funds in low risk government securities instead of providing credit to individuals.
It causes home loans to become dearer, while the opposite effect is seen when the reverse repo rate is decreased.
Difference between Reverse repo rate and Repo rate
The basic differences between reverse repo rate and repo rate are as follows
- High reverse repo rate dries up the money supply while a high repo rate results in injecting more liquidity in the system.
- Reverse repo rate is always lower than the repo rate.
This was all about the concept of reverse repo rate and its impact on the economy. For more such interesting concepts on Economics for Class 12, stay tuned to CoolGyan’S.
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Frequently Asked Questions on Reverse repo rate
Who decides the value of Reverse repo rate?
Reverse repo rate is decided by the Monetary policy committee (MPC), which is headed by the Governor of RBI.
What is the current Reverse Repo Rate in India?
As of May 22nd, 2020, the Reverse repo rate decided by RBI is 3.35 %