Repo Rate vs Reverse Repo Rate

Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Difference Between Repo Rate vs Reverse Repo Rate

Repo Rate vs Reverse Repo Rate:

  • Repo Rate is the rate at which the commercial banks of a particular country borrow money from that country’s central bank as and when required.
  • Reverse Repo Rate is when the central bank borrows back money from other commercial banks to control the money supply in the markets.

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Example of Repo Rate vs Reverse Repo Rate

To understand the two concepts, we can consider this example. ABC bank has a shortfall of $10 million in its transactions. It approaches the Central bank of the country to cover up the shortfall. The Central bank offers a loan to ABC bank at a rate of 5.0% for 20 years. This is the repo rate (repurchase rate). If ABC bank has any excess deposit in its accounts, it must deposit the same with this Central bank, for which it pays a rate. This is the reverse repo rate.

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Bank Rate vs. Repo Rate Explained in Video

Repo Rate vs Reverse Repo Rate Infographics

Here we provide you with the top 5 differences between Repo Rate and Reverse Repo Rate.

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Repo Rate vs Reverse Repo Rate Key Differences

The key differences between Repo vs and Reverse Repo Rate are as follows

Repo rate and reverse repo rate are interlinked. The government uses these to control inflation and other monetary policies. As they walk hand in hand, it isn’t easy to compare each movement separately. Let us see how an increase in both rates affects the economy.

Increase in Repo Rate

An increase in the repo rate leads to increased borrowing costs for commercial banks. This increased cost is passed on to customers by making lending instruments more expensive (for example, an increase in installments of loans or other borrowing costs, etc.). This reduces borrowing activities in markets, due to which economic growth slows down, which controls inflation.

Hence, the Government uses this measure when prices rise, and there are no other ways to curb inflation.

Increase in Reverse Repo Rate

When the reverse repo rate increases, banks tend to lend more money to the central bank due to increased profitability and safer lending venues. This results in a lack of market liquidity, as commercial banks prefer to lend all excess funds to the central bank. Due to this liquidity crunch, thus again controlling inflation.

Decrease in Repo Rate

This scenario is exactly the opposite of increased rates. Due to decreased repo rates, banks tend to reduce their market lending rates, which increases credit growth in the economy. As a result, more money flows into the market. As a result, more industries come up due to the easy availability of loans, which prices go down, and a healthy competitive market builds up.

Decrease in Reverse Repo Rate

This happens simultaneously with an increase in the repo rate. Due to the decrease in both rates, the flow of money increases in the market, thereby enhancing the purchasing power of an individual.

Repo Rate vs Reverse Repo Rate Head to Head Differences

Let’s now look at the head to head differences between Repo Rate and Reverse Repo Rate

CategoryRepo RateReverse Repo Rate
MeaningThe rate at which the Central Bank lends money to other commercial banks of the country.The rate at which the Central Bank borrows money from the other commercial banks of the country.
Rate comparisonHigher than reverse repo rate (currently 6.5% in India).Lower than repo rate (currently 6.25% in India).
Impact on BanksIncreased Repo Rates lead to increased costs for the commercial bank, which leads to making banking products more expensive.Increase in Reverse Repo Rate leads to more lending activity for commercial banks due to higher profitability.
Impact on LiquidityDue to readily available funds from Central Bank at a particular Repo Rate, commercial banks do not face a liquidity crunch. Thus it controls liquidity crunch.Due to excess liquidity in the market, Central Bank may start borrowing funds from commercial banks at the reverse repo rate. Thus this rate controls an excess flow of funds.
Impact on InflationIncrease in repo rate leads to increased cost of borrowing for commercial banks which is passed on to customers. This leads to slowing down of borrowing activity in the market, due to which economy as a whole slows down, thus controlling inflation.Increase in reverse repo rate leads to increased lending activities by banks and decreased money flow in the markets, due to which inflation gets controlled.

Conclusion

The government uses repo and reverse repo rates to control the flow of money in the economy, which is essential for all economic levels, be it individual, industrial, corporate or national levels. Time and again, these measures are taken up for proper controls. They have been wisely devised to act in different situations, and every country has certain methods in which it requires these types of rates in controlling inflation.

This has been a guide to repo rate vs. reverse repo rate. Here we also discuss the top 5 differences between the two, infographics, and a comparison table. You may also have a look at the following articles –

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