Repo Rate & Reverse Repo Rate

What is the Repo Rate and Reverse Repo Rate?

The Repo Rate, also known as the repurchase rate, “is the interest rate at which a central bank lends money to commercial banks for a short period.” In simple terms, it is the cost of temporary borrowing for banks. For example, if the repo rate is 5%, a bank borrowing $100 million from the central bank would need to repay $105 million after a specified period. By adjusting the repo rate, the central bank can influence the amount of money circulating in the economy, affecting borrowing costs and inflation rates.

The Reverse Repo Rate “is an interest rate at which the central bank borrows money from commercial banks.” It is an essential part of monetary policy and complements the repo rate. In simpler terms, it is the interest rate that the central bank pays to banks for temporarily depositing money. For example, if the reverse repo rate is 4%, a bank lending $100 million to the central bank would receive $104 million in return after a specific period.

Repo and Reverse Repo rates significantly impact borrowing costs and liquidity in financial markets. These rates affect banks' lending and investment decisions, affecting overall economic activity. During economic events such as inflation, central banks may adjust these rates to manage the money supply. In economic downturns or crises, repo and reverse repo rate changes become crucial tools for regulating credit flow, encouraging or discouraging borrowing, and stabilizing financial conditions.

I have attached a video below that provides a detailed explanation of the concept mentioned above.