What is a Reverse Repo Rate?

What is a Reverse Repo Rate?

Reverse Repo Rate

Reverse Repo Rate

Reverse repo rate is a banking phenomenon. It is used specifically in the case of borrowings done by Reserve Bank of India. Reverse repo rate refers to the borrowing rate for a short term period. It is the actual rate at which Reserve Bank of India does the borrowings from other banks.

In general, the reverse repo rate is considered by the central bank of the country. In India, the central bank is the Reserve Bank of India. Thus, it is the rate considered by the Reserve Bank of India to accept borrowings from commercial banks within India. Reverse repo rate is a kind of monetary instrument. It plays a vital role while framing the existing monetary policy of the country. Its main purpose is to monitor the money supply in a particular country.

Situation for considering reverse repo rate

A situation arises in the banking system that there are too much floating funds. These funds are in excess to the normal standards in the banking system. It is a natural tendency of banks to lend excess money to the borrowers such as individuals or companies. But this involves high amount of risk factors. Moreover, a long and cumbersome procedure is also involve in granting loans such as verifying credit worthiness of borrowers and checking the documentation submitted by them. If the borrower makes default or forgets to pay EMIs, then the lender has to send constant reminders to the borrowers for paying the loan amount.

To avoid all these paperwork and risks, banks decide to lend money to Reserve Bank of India. This is always safe to the interests of banks. If there is increase in the reverse repo rate, it reflects higher interest rate received by banks from RBI.

Reverse repo rate and money supply

Let us understand the reverse repo rate from the money supply perspective. If the reverse repo rate increases, the money supply decreases and vice versa. It is assumed that the other influencing factors remain static. If you have heard in the news or read in the newspapers that there is an increase in the reverse repo rate, it implies that commercial banks are getting more opportunities to lock their funds with the Reserve Bank of India. The commercial banks are not providing borrowings to the individuals or the companies. They do not want to take the risks by granting loans to the general customers. They are acquiring higher rates of interest from Reserve Bank of India and hence, are interested in lending to it.

An excess fund in the banking system is nothing but the liquidity. Reverse repo rate refers to the rate adopted by central banking system for absorbing this liquidity. There is linkage between the repo rate and the reverse repo rate with 1% difference in them.

Conclusively, a knowledgeable person must be aware about the terms such as repo rate, reverse repo rate, and so on. A layman comes across such terms while reading newspapers or while watching news on the television. So, next time when you read or hear that reverse repo rate has been increased, you need to understand that commercial banks have reduced their borrowings to the general customers.