Repo Rate and Reverse Repo Rate

What is Repo rate? 

Definition: Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds. It is an instrument of Monetary policy. Repo rate is used by monetary authorities to control inflation.

Description: In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in arresting inflation.

A reduction in the repo rate helps banks get money at a cheaper rate and vice versa. The repo rate in India is similar to the discount rate in the US.

What is Reverse Repo rate?

Reverse Repo rate is the rate at which the RBI borrows money from commercial banks. 

Banks are always happy to lend money to the RBI since their money are 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.