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Repo and Reverse Repo

Repo and Reverse Repo
Highlights

The Reserve Bank of India (RBI) on April 6 maintained status quo on policy rate by leaving the repurchase rate (or repo rate) unchanged at 6.25 per...

The Reserve Bank of India (RBI) on April 6 maintained status quo on policy rate by leaving the repurchase rate (or repo rate) unchanged at 6.25 per cent in its first bimonthly policy of FY18. The central bank also kept the cash reserve ratio (CRR) unchanged at 4 per cent. However, it raised the reverse repo rate by 25 basis points to 6 per cent.

CRR is the amount of funds that the banks have to keep with the RBI. If the central bank decides to increase the CRR, the available amount with the banks comes down. The RBI uses the CRR to drain out excessive money from the system. The rate at which the RBI lends money to commercial banks is called repo rate. It is an instrument of monetary policy.

Whenever banks have any shortage of funds they can borrow from the RBI. A reduction in the repo rate helps banks get money at a cheaper rate and vice versa. The repo rate in India is similar to the discount rate in the US. Reverse Repo rate is the rate at which the RBI borrows money from commercial banks.

Banks are always happy to lend money to the RBI since their money are in safe hands with a good interest. An increase in reverse repo rate can prompt banks to park more funds with the RBI to earn higher returns on idle cash. It is also a tool which can be used by the RBI to drain excess money out of the banking system, according to http://flame.org.in.

The RBI seems to have kept its repo rate unchanged at 6.25 per cent for a third consecutive policy meeting as it continues to guard against any potential flare-up in inflation and an uncertain global economic environment. With wholesale price inflation soaring to 39-month high of 6.55% and retail inflation to 65% in February, inflation continues to be a concern for the apex bank.

The RBI uses Repo and Reverse Repo to control money supply in the system. Hike in reverse repo rates is a good news for banks as they can earn higher interest on money lend to the RBI. The unchanged repo rate means that there will be no impact on interests on loans and deposits in banks.

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