Repo (Repurchasing Option) is a contract between two parties when one party gives a credible security to the other as a collateral to avail a short term (one day) loan. At the end of the time period, the loan is repaid and the security is repurchased. The borrower pays an interest rate called repo rate.
Repo under the RBI’s monetary policy
Though repo is a market instrument, it is most popular as a monetary policy or liquidity exercise.
Under the RBI repo, commercial banks take one day or overnight loans from the RBI by giving eligible securities as collateral. After one day, they pay an interest called repo rate, and the securities have been repurchased from the RBI.
The repo operation is very useful in the monetary policy because:
It helps the RBI to influence the economy and the interest rate of commercial banks through the repo rate
It helps banks to tide over their liquidity problems.
