What is Repo Rate and Reverse Repo?

Latest Update on 7th February 2025

• Current Repo Rate: 6.25%
• Current Reverse Repo Rate: 3.35%

On 7th February 2025, the RBI’s six-member Monetary Policy Committee (MPC) cut the repo rate by 25 basis points to 6.25% after keeping it at 6.50% for two years.

The Repo Rate full form is Repurchase Agreement or Repurchasing Option; banks get loans from RBI by selling qualifying securities. It is the interest rate at which the Reserve Bank of India (RBI) loans money to commercial banks.

The commercial banks and RBI discuss and agree to repurchase the securities at a set price. This is done when banks are short on funds and need to maintain liquidity under volatile market conditions.

Also Read: What Is An Account Aggregator?

Similar to how interest rates work for individuals and businesses when they take a loan from any bank, the repo rate is the interest rate that is levied on commercial banks when they demand a loan from the RBI.

After the one-day loan period ends, the commercial bank must repay the RBI the total loan amount plus the remainder based on the repo rate.

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The reverse repo rate is the interest rate at which commercial banks deposit short-term funds with the RBI. The objective of the RBI behind imposing the reverse repo rate is to allow commercial banks to park their excess money reserves with the RBI and earn interest on their deposited money.

For instance, if multiple banks have a surplus of money due to seasonal demand or any other economic activity, they can deposit their surplus with the RBI at the current reverse repo rate for up to one day.

Repo Rate Cut Impact

If the RBI cuts the repo rates, it will be easier for banks to take loans from the RBI at lower rates, allowing higher liquidity into the banking system. Moreover, banks can reduce their lending rates, allowing customers to get loans at lower interest rates for the longer term. This will allow customers to borrow and spend more, which will help economic growth.

However, it is up to banks whether or not they want to provide their customers with lower repo rate benefits via lower loan rates.

Reverse Repo Rate Cut Impact

When a reverse repo rate cut is made, commercial banks earn less on the deposit made with RBI. In this case, banks can invest in more lucrative options, such as money markets, which increases the overall liquidity of the economy.

The cuts in repo and reverse repo rates affect the interest rates, loan borrowing and overall financial markets. Let us understand them:

Impact of Repo Rate Cuts

• Lower Loans for Banks: When RBI lowers the repo rate, commercial banks can take out loans at lower interest rates.
• Lower Rates for Customers: Lower repo rates allow banks to offer customers loans at reduced interest rates. This benefits customers with affordable home, car and personal loans.
• Stock Market: Lower repo rates increase corporate profitability, which enables businesses to borrow at lower rates.
• Inflation Regulation: The increase in demand and spending creates upward pressure on inflation levels above the supply. The RBI then checks the price and inflation to ensure that they remain within target levels.
• Effect on Currency Value: The RBI monetary policy repo rate cut can lead to devaluation of the Indian Rupee due to its lesser appeal to foreign investors for Indian investments. It can cause capital outflow.

Also Read: Cost Inflation Index for FY 2024-25

Impact of Reverse Repo Rate Cut

• Lower Earning of Banks: When the reverse repo rate is reduced, banks earn less on deposits made with the RBI.
• Increased Market Liquidity: As banks earn less, they can lend more to companies and individuals, thus increasing the economy's cash flow.
• Investment Encouragement: When the reverse repo rate is cut, banks are prompted to invest in higher-yielding assets such as government securities, corporate bonds, and money market instruments.

Also Read: Invest in Equity Linked Saving Scheme (ELSS) Mutual Funds

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