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what is Reverse Repo Rate?
Reverse Repo Rate is defined as the rate at which the Reserve Bank of India (RBI) borrows money from banks for the short term. It is an important monetary policy tool employed by the RBI to maintain liquidity and check inflation in the economy. The Reverse Repo Rate helps the RBI get money from the banks when it needs. In return, the RBI offers attractive interest rates to them. The banks also voluntarily park excess funds with the central bank as it provides them with an opportunity to earn higher interest on surplus money. The Reverse Repo Rate is decided by the Monetary Policy Committee (MPC), headed by the RBI Governor. The decision is taken in the bi-monthly meeting of the Committee.
Difference between repo rate and reverse repo rate?
Under the Reverse Repo Rate, banks deposit excess funds with the RBI and earn interest for it.
The opposite of Reverse Repo Rate is the Repo Rate, at which the banks borrow short-term money from the RBI.
Impact of Reserve Repo rate hike and cut:
The central bank increases or decreases the reverse repo rate depending on the macroeconomic factors. An increase in the Reverse Repo Rate provides an incentive to the banks to park their surplus funds with the central bank on a short-term basis, thereby reducing liquidity in the banking system and overall economy. In other words, the RBI gets surplus money from banks against the collateral of government securities on an overnight basis.
Whenever RBI decides to reduce the reverse repo rate, banks earn less on their excess money deposited with the Reserve Bank of India. This leads the banks to invest more money in more lucrative avenues such as money markets, which increases the overall liquidity available in the economy. While this can also lead to lower interest rate on loans for the bank’s customers, the decision will depend on multiple factors including the bank’s internal liquidity situation and the availability of other potentially less risky and equally lucrative investment opportunities.