Repo suggests the rate at which liquidity is injected in the banking system where as Reverse Repo is the rate at which RBI absorbs liquidity from the banks. RBI controls the money supply in the country by effecting the changes in repo rate & reverse repo rate. Therefore repo and reverse repo rate are known as key policy rates.
The effects of change in Repo Rate:
Repurchase options (REPOS) or Ready Forward or Repurchase agreement is temporary Liquidity Adjustment Facility (LAF) extended by RBI to banks on the terms that the amount should be repaid on a predetermined future date. Repo rate is the rate at which the RBI lends shot-term money to the banks against the security of all SLR-eligible transferable Government of India- dated Securities,Treasury Bills and State Development Loans (SDL). Under Repo Scheme (LAF – Repo), RBI would debit to concerned Bank’s RC SGL Account of accepted securities and release the funds to the credit of concerned bank’s current account. When RBI increases the repo rate borrowing under Repo scheme becomes more expensive. Therefore, when RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; which would decrease the supply of the money in the market. Similarly, if it wants to make it cheaper for banks to borrow money it reduces the repo rate; which would increase the supply of the money in the market. The Reserve bank of India introduced Repo auctions in India, during December 1992. The repo rate became the independent variable policy rate, marking a shift from earlier method of adjustment of various policy rates, in terms of the policy announcements made by RBI on 03/05/2011.
The effects of change in Reverse Repo:
Reverse Repo rate is the rate at which the Reserve Bank of India (Central Bank of a country) borrows money from commercial banks in India. An increase in reverse repo means commercial banks earn more interest when they park their funds with RBI, which would decrease the supply of the money in the market.
LAF corridor: LAF corridor is the spread between Repo and Reverse Repo rate which is 1%* at present. LAF means Liquidity Adjustment Facility. (*The narrow policy corridor is reduced from 1% to 0.50% w.e.f. 05.04.2016)
Updated on 05.04.2016: The Apex Bank in its first bi-monthly report dated 05.04.2016 said that it would continue to provide liquidity as required but progressively lower the average ex ante liquidity deficit in the system from one per cent of NDTL to a position closer to neutrality; The narrow policy rate corridor from +/- 100 basis points to +/-50 Basis points by reducing the MSF rate by 75 BPS and increasing the reverse repo rate by 25 BPS with a view to ensure finer alignment of the weighted average call rate (WACR) with the repo rate. Pursuant to above policy, the reverse repo rate under the LAF stands adjusted to 6.0 per cent and the marginal standing facility (MSF) rate to 7.0 per cent.
Related articles: (i) What is bank rate? (ii) How RBI monitors money circulations, (iii) what is Marginal Standing Facility, (iv) CRR and SLR: a tool gor expansion & contraction of bank credits.,