What are Repo and Reverse Repo Rates?

Dear Mr.Satinderpal Singh

Sorry for the delay in answering, a good question.

First address the meaning of these two terms and then their significance.

The ‘Repo Rate’ is the rate at which the Reserve Bank of India (RBI) is willing to lend money to commercial banks. The ‘Reverse Repo Rate’ is the rate at which the RBI is willing to pay to accept surplus money lying with commercial banks.

Now let us address the significance of these rates. These rates have the significance of influencing the market interest rates for the whole economy. There is no direct and binding linkage between the RBI denominated rates and banks’ rates but it only has indirect, persuasive influence. When RBI lowers the two rates, it is sending a strong and clear signal that RBI believes the lending and deposit rates need to go down. The actual reduction achieved out of competition. One bank takes the cue and reduces its rates and others will follow. This is called the transmission of interest rate changes.

However, it has happened in the recent past that the commercial banks refused to transmit the rate cuts, forcing the RBI to intervene (again only persuasive) and speak out that there was a clear need for transmission of the rate cut.

Converse persuasion attempts were also made in the recent past where the central government and commercial banks desired a rate cut but the RBI did not oblige and the commercial banks went ahead on their own and cut rates thus putting pressure on the RBI to cut Repo and Reverse Repo rates.

In conclusion Repo and Reverse Repo rates are RBI’s interest rate policy tools that strongly influence the general lending and deposit interest rates by commercial banks and other financial institutions.

Thank you,

With Best Regards,

Anand

Please Note: This is almost a reproduction of the question I had answered on the website ‘Quora’, which I thought could be useful to the visitors to this blog site also.