Repo Rate and Reverse Repo Rate

Repo Rate is at 8.25% Reverse Repo Rate is at 7.25%

Introduction

• Repo or repurchase agreement is a window which enables a bank or a financial institution to borrow money in the short-term. In the transaction, the entity in question sells government securities or bonds to the lender (another bank or institution), with an agreement to buy the securities back after a specified time and price

• A repo instruments enable short-term borrowing through sale operations in debt instruments. In a developed financial market, Repos are recognized as a very useful money market instrument.

Repo Instrument

• The borrower parts with securities to the lender with the agreement to purchase, them at the end of the fixed period at a specified price. The difference between the purchase price and the original price is the cost for the borrower. In India, Repos are normally conducted for a period of 3 days.

Advantages of Repo

 • Repo entails instantaneous legal transfer of

ownership of the eligible securities. It helps to promote greater integration between the money and the Government securities markets. Repo can be used to facilitate Government’s cash management. Repo is a very powerful and flexible money market instrument for modulating market liquidity.

Significance of Repo Transactions

• RBI conducts a repo, what it does in effect is it lends to bank by purchasing securities and selling them bank at a predetermined price. When RBI does a reverse repo, it borrows from bank by selling them securities and buying them back at a future date. In December 92, the first repos auctions took place. Presently, the period of repos are maintained at 14days

Repos Auctions

• All transactions are effected at Mumbai and the deals are put through the Subsidiary General Ledger (SGL) account with the RBI. SGL form is the form of transfer government securities from SGL account of the bank to SGL account of another bank maintained with public debt office RBI. Banks can also enter into reverse repo transactions in T-bills and GoI dated securities to enable short-term adjustment in liquidity in the system.

Reverse repo rate

• Reverse repo rate is the rate of interest at which the RBI borrows funds from other banks in the short term. Like the repo, this is done by RBI selling government bonds to banks with the commitment to buy them back at a future date.The banks use the reverse repo facility to deposit their short-term excess funds with the RBI and earn interest on it. RBI can reduce liquidity in the banking system by increasing the rate at which it borrows from banks. Hiking the repo and reverse repo rate ends up reducing the liquidity and pushes up interest rates.

The Market

• In countries like the USA, Canada, Germany and Australia repos are effectively used by central banks as part of open market operations to influence bank reserves/ overnight or short-term interest rates and thereby the liquidity and monetary conditions in the country. As of now, the market has 15 GoI securities with repo facility, the total value of which is around Rs. 60,000 crore .

Conclusion

 • The money market in India, which traditionally consisted largely

of call/ notice money market, now comprises many other instruments such as CP, CDs and Repos. The repo trade at this stage offers a quick medium for developing a market for short-term funds especially as the transactions are collateralized in the case of non-banks, To enable orderly development of the money market, prudential limits have been set on borrowing and lending in the call money market for different categories of participants based on different benchmarks.