Reverse repo is liquidity adjustment operation by the RBI. It is an operation done by the RBI to absorb excess liquidity from the banking system.
Reverse repo is a term used to describe the opposite side of repo transaction. Under LAF, commercial banks can give their excess cash to the RBI for one day and can avail an interest. The interest rate given by the RBI when a commercial bank parks its excess cash under the reverse repo facility is called reverse repo rate. Unlike in the case of repo, there is no collateral under reverse repo.
The typical scenario of India’s LAF operation is that there will be more repo transactions than reverse repo transactions. This means that banks often depend upon the RBI to get temporary loans.
Reverse repo – as an ordinary market instrument
Apart from the central bank angle, reverse repo is an operation prevailing in the financial market. Here, it works as the same manner as in the case of LAF. Difference is that there is no central bank or commercial bank; rather, the parties are ordinary lender and borrower.
Reverse repo in the ordinary market sense implies one party (borrower) gives back the underlying securities of a short-term loan to get an interest (from the lender). The principal is paid back.
