Repo rate is interest rate charged by the RBI on the overnight loans given to the commercial banks under the Liquidity Adjustment Facility. It is the poicy rate for the RBI to target inflation and thus to ensure price stability in the economy. The repo rate decision is taken by the RBI’s Monetary Policy Committee. Hence, the repo rates’ unique value is that it is used as the policy rate or interest rate anchor by the RBI to target inflation. Here, when repo rate is changed, it will bring a corresponding change in the lending rates of commercial banks, if banks follow the RBI’s initiative. As of now, the RBI is not providing one day loans under the overnight repo facility. Rather, there is the variable rate repo and other liquidity support instruments. The one day repo has been discontinued since February 2020. This doesnt mean that repo rate is discountinued. Rather the repo is the star of the monetary policy instruments. Repo rate is also used as an external benchmark for determining the interest rates of banks. Most of the other rates of the RBI are set in accordance with the repo rate.
Repo rate is the interest rate anchor
Significance of the repo rate is that it is the interest rate anchor (short- term) and is used by the RBI to target inflation. It is the most important monetary policy tool of the RBI and because of its importance, repo rate is known as ‘the policy rate’.
Under the inflation targeting monetary policy framework repo rate is considered as the only policy instrument to influence the targeted inflation and thus to achieve price stability.
Following procedures are there under a repo transaction between the RBI and commercial banks:
1. Banks give eligible securities (securities identified by the RBI {like government bonds} and at the same time which are above the SLR limit) as collateral to the RBI.
2. RBI gives one day/overnight loan to the banks and charges an interest rate called repo rate from the bank.
3. Bank repays the loan after one day and repurchases the security it has given as collateral.
Reverse repo is the opposite of repo. Here, commercial banks deposits money with the RBI while getting an interest rate called reverse repo rate.
