What is the Difference Between Repo Rate and Reverse Repo Rate?

The repo rate and reverse repo rate are two key tools used by central banks, such as the Reserve Bank of India (RBI), to manage liquidity and control inflation in an economy. They differ in terms of the roles of the lender and borrower, their objectives, and their impact on the economy.

Repo Rate:

• The repo rate is the interest rate at which the central bank (e.g., RBI) lends money to commercial banks.
• The lender is the central bank, and the borrower is the commercial bank.
• The main objective is to manage short-term shortages of funds and control inflation.
• A higher repo rate results in higher borrowing costs for commercial banks, which can lead to more expensive loans for consumers.

Reverse Repo Rate:

• The reverse repo rate is the interest rate at which commercial banks can park their surplus funds with the central bank.
• The lender is the commercial bank, and the borrower is the central bank.
• The main objective is to reduce liquidity in the economy and maintain control over inflation.
• A higher reverse repo rate encourages commercial banks to deposit more funds with the central bank, reducing the amount of money available for lending.

In summary, the repo rate is the interest rate at which the central bank lends money to commercial banks, while the reverse repo rate is the rate at which commercial banks lend money to the central bank. The repo rate injects liquidity into the market, whereas the reverse repo rate absorbs liquidity from the market. The repo rate is typically higher than the reverse repo rate.

Comparative Table: Repo Rate vs Reverse Repo Rate

The main difference between the repo rate and the reverse repo rate lies in their purposes and the parties involved. Here is a table highlighting the key differences between the two rates:

The repo rate is a benchmark interest rate at which commercial banks borrow money from the central bank for short periods, against collateral. On the other hand, the reverse repo rate is the interest rate offered by the central bank to commercial banks on their deposits with the central bank.

Both repo rate and reverse repo rate are components of the Liquidity Adjustment Facility (LAF) and assist in controlling inflation by either reducing the money flow (repo rate) or encouraging banks to deposit funds with the central bank (reverse repo rate). The reverse repurchase rate depends on the repo rate, and it is consistently lower than the repo rate due to the spread between them, which constitutes the central bank's income.