Reverse Repo Rate

This is the exact opposite of repo rate.

The rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed the reverse repo rate. The RBI uses this tool when it feels there is too much money floating in the banking system; this too leads to inflation.

For example, take a look at the housing industry today — there is so much of money available in terms of bank loans and increased salaries that the prices for homes, and for land, has sky-rocketed.

If the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer them a lucrative rate of interest. As a result, banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain amount of risk)

Consequently, banks would have lesser funds to lend to their customers. This helps stem the flow of excess money into the economy.

Though RBI can use both repo and reverse repo to control the amount of money in the system, it is the reverse repo that the RBI prefers as a credit management tool. It was only during the October 2006 credit policy that the RBI, after a long gap, increased repo rate to control inflation.

As of today, the reverse repo rate stands at 6% and the repo rate is 8.5% . Any monetary authority lends money at a higher rate and borrows at a lower rate. RBI, too, is a clever money manager. It lends money to banks at 8.5% per cent (repo rate) and borrows money from banks (reverse repo rate) at only 6 per cent, maintaining a neat difference/ profit of 2.5 per cent.

How this affects us: Again, if the RBI increases the reverse repo rate, consider it bad news. It means the banks have less money to lend — since they will keep quite a bit of it with the RBI. As a result, we will have to pay a higher rate of interest if we are planning to apply for a loan.

If we are lucky, though, and the bank does not want to lose us as a clients, it may absorb the increased interest and not pass the cost to us. But that generally does not happen and we all know that. Everyone wishes to wash their hands off when the times are difficult.

Advertisements
Tagged

2 thoughts on “Reverse Repo Rate

  1. Sudhix says:

    Hi, a small doubt. Why too much money in banking system leads to inflation??

  2. Saravanan says:

    @Sudhix

    Buddy, since more people have high spending power and less goods to buy, the people start buying the required goods at premium rate thus increasing the inflation, where as if the people have low spending power (less money to spend) they cant buy goods at premium rate. Hence there should not be more money in the banking system which increases inflation.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: