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Sunday, April 07, 2013

What is Repo, Reverse Repo and CRR





What is a Repo Rate?
Repo is the short for "repurchase option" for the central bank of the country e.g. RBI. It is a means of short-term borrowing, wherein banks sell approved government securities to RBI and get funds in exchange. In other words, in a repo transaction, RBI repurchases government securities from banks, depending on the level of money supply it decides to maintain in the country's monetary system.


Repo rate is also called as the discount rate at which banks borrow from RBI. It is an instrument of monetary policy.

Reduction in repo rate will help banks to get money at a cheaper rate, while increase in repo rate will make bank borrowings from RBI more expensive. If RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate. Similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.


What is Reverse Repo rate?
Reverse repo is the exact opposite of repo. In a reverse repo transaction, banks purchase government securities form RBI and lend money to the banking regulator, thus earning interest. Reverse repo rate is the rate at which RBI borrows money from banks. Banks are always happy to lend money to RBI since their money is in safe hands with a good interest.

An increase in reverse repo rate can prompt banks to park more funds with the RBI to earn higher returns on idle cash. It is also a tool which can be used by the RBI to drain excess money out of the banking system.

In between Repo and reverse repo, there is some money which is always held by RBI. This cash held by RBI is defined in terms of CRR.


Cash reserve Ratio (CRR)
Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with the RBI. If the central bank decides to increase the CRR, the available amount with the banks comes down. The RBI uses the CRR to drain out excessive money from the system.

Scheduled banks are required to maintain with the RBI an average cash balance, the amount of which shall not be less than 4% of the total of the Net Demand and Time Liabilities (NDTL), on a fortnightly basis.


Conclusion
1) Repo rate is always higher than the reverse repo rate.
2) RBI keeps a control on the repo rate, reverse repo rate and CRR to typically balance the running inflation and the economic growth.

Cheers

Manoj Arora

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