What is the difference between Repo Rate and Reverse Repo Rate?

The Repo Rate and Reverse Repo Rate are both key policy rates set by the central bank, but they serve different purposes and have opposite effects on the banking system.

1. Repo Rate: The Repo Rate is the rate at which the central bank lends money to commercial banks for a short period, usually overnight. When commercial banks face a shortage of funds, they can borrow from the central bank through repurchase agreements (repos) by selling government securities with an agreement to repurchase them at a future date. The Repo Rate acts as a benchmark interest rate in the economy and influences the overall interest rate environment. An increase in the Repo Rate makes borrowing more expensive, while a decrease in the Repo Rate makes borrowing cheaper.

2. Reverse Repo Rate: The Reverse Repo Rate, on the other hand, is the rate at which the central bank borrows money from commercial banks. It is the interest rate that the central bank offers to banks for temporarily parking their excess funds with the central bank. Commercial banks earn interest on these funds, and it provides them with a riskfree avenue to invest their surplus liquidity. The Reverse Repo Rate is usually set slightly below the Repo Rate. An increase in the Reverse Repo Rate incentivizes banks to lend more to the central bank, thereby reducing the amount of money available for lending in the economy. Conversely, a decrease in the Reverse Repo Rate encourages banks to deploy more funds in lending activities, stimulating economic growth.

In summary, the Repo Rate is the rate at which the central bank lends money to banks, while the Reverse Repo Rate is the rate at which the central bank borrows money from banks. These rates are tools used by the central bank to manage liquidity in the banking system and influence the overall interest rate levels in the economy.