In this article, we will try to understand what is REPO, Reverse REPO, Bank Rate and then we will discuss relationship among them. This is important to understand not only from exam perspective ( RBI Grade B, UPSC- CSE, and other banking exams) but to comprehend the basic economy news.
Repo Rate and Reverse Repo Rate
Repo rate is the interest charged by RBI on the loan given to the bank. This loan is given to the bank against the collateral of govt. security. Bank can borrow up to a certain amount under this facility. Also the govt. security which a bank can put as collateral cannot be out of Bank’s Statutory Liquidity Requirement (SLR). SLR is the amount of investment (as a percentage of its NDTL) which bank has to do in a liquid asset such as govt. Security, Gold, Cash.
Reverse Repo is the interest which a bank will get if it parks its fund to RBI. Against this parking of fund with RBI, Bank gets govt. security.
This facility provided to the Banks is called Liquidity Adjustment Facility (LAF). As through this facility, the bank maintains its liquidity, either by parking its excess cash with RBI or borrowing from RBI in case of short of cash.
Marginal Standing Facility
Apart from REPO and Reverse Repo, there is something else which is called the Marginal Standing Facility (MSF). It has been already mentioned that only a limited amount can be borrowed under the Repo. Now if the bank wants to borrow more funds he can utilize MSF. Under MSF he can put 2% of its NDTL (Net demand and Time Liability) as collateral to RBI to borrow the money. The interest which is charged is called MSF rate.
Bank Rate
Prior to the introduction of LAF, Banks can borrow from the RBI. And interest rate which was charged is called the bank rate. After the introduction of LAF, “Bank Rate” has lost its purpose. Now the Bank rate is used to determine the penalty in case Bank defaults in term of not maintaining CRR, SLR etc.
Further Bank Rate is equal to MSF Rate ( Don’t consider that the Bank rate and MSF rate are same, only their values are same but their meaning is different)
The relationship between the Reverse Repo rate, Repo rate, and Bank rate/ MSF.
As we have understood Repo rate is the interest rate at which RBI lends and Reverse Repo rate is the interest rate which a bank will get for parking its money with RBI against Govt. security. Now in this scenario, Reverse Repo rate will always be less than the Repo rate. Else, Bank will borrow from RBI at a lower rate and again park this money to RBI at the higher rate.
Further, Bank rate which is equal to MSF rate and MSF rate is the facility for Bank to borrow extra money over and above under REPO window. This facility is utilized by a bank when it has fully utilized its REPO facility. So it has to be greater that REPO rate else bank will borrow under this facility prior to exhausting under Repo facility,
So 1st relationship between the rates
Reverse Repo < Repo < MSF (Bank Rate)
Further, RBI generally kept a constant differential between the Repo rate and Reverse Repo rate which is called LAF corridor. Presently this corridor is 25 basis point (0.25%).
Similarly, a constant differential is maintained between Reverse Repo and MSF rate. It is called Policy Corridor. It is presently 50 basis point (0.50%)
2nd Relationship between the rates
Reverse Repo = Repo – 0.25%
Bank Rate = MSF rate = Repo+0.25 %
This relationship has been presented figuratively here.
In case of any doubt regarding this ask in the comment section.
See also:
- NBFC crisis in India
- Reasons behind Indian currency depreciation
- RBI framework for NPA resolution
- Best Youtube channel for economics