Repo stands for ‘repurchase option’ or ‘repurchase agreement’. It is a form of short term borrowing that allows banks or financial institutions to borrow money from other banks or financial institutions against government securities with an agreement to buy those securities back after a specified time period and at a predetermined price (which is higher than the initial sell price).A repurchase agreement is a secured way of raising short-term capital for banks. The duration of these loans generally varies between one day to a fortnight. In this system, the borrower enters into a repo or repurchase agreement, whereas, for the lender, it’s a reverse repurchase agreement or reverse repo.In India, the Reserve Bank of India or RBI (which is the central bank in the country) lends money to commercial banks with an interest rate which is called repo rate. These loans are sanctioned in exchange for securities to help the banks achieve their financial goals. On the other hand, RBI also has provisions for banks to park their excessive funds for which RBI pays interest, which is determined by reverse repo rate. This interest rate is also applicable when RBI borrows money from commercial banks. RBI uses repo and reverse repo to maintain economic stability in the country. When there is a need for an economic boost, RBI pumps funds into the system by helping commercial banks borrow money from the bank. Using repo, banks raise the necessary capital to increase their lending capacity. This ensures liquidity for the bank and proper cash flow into the market. But, in the case of inflation, RBI uses reverse repo to absorb funds from the market to regulate the lending capabilities of commercial banks.

Monetary Policy Committee - It is a statutory and institutionalized framework under the Reserve Bank of India Act, 1934, for maintaining price stability, while keeping in mind the objective of growth. The Governor of RBI is ex-officio Chairman of the committee. The MPC determines the policy interest rate (repo rate) required to achieve the inflation target (4%). An RBI-appointed committee led by the then deputy governor Urjit Patel in 2014 recommended the establishment of the Monetary Policy Committee.

Repo Rate: It is the interest rate at which the central bank of a country lends money to commercial banks. The central bank in India i.e. the Reserve Bank of India (RBI) uses repo rate to regulate liquidity in the economy. In banking, repo rate is related to ‘repurchase option’ or ‘repurchase agreement’.When there is a shortage of funds, commercial banks borrow money from the central bank which is repaid according to the repo rate applicable. The central bank provides these short terms loans against securities such as treasury bills or government bonds. This monetary policy is used by the central bank to control inflation or increase the liquidity of banks. The government increases the repo rate when they need to control prices and restrict borrowings. On the other hand, the repo rate is decreased when there is a need to infuse more money into the market and support economic growth.An increase in repo rate means commercial banks have to pay more interest for the money lent to them and therefore, a change in repo rate eventually affects public borrowings such as home loan, EMIs, etc. From interest charged by commercial banks on loans to the returns from deposits, various financial and investment instruments are indirectly dependent on the repo rate.

Impact of Repo Rate in Economy

• Repo rate is an important component of the monetary policy of the nation, and it is used to regulate the liquidity, inflation, and money supply of the nation. Additionally, repo rate levels create a direct impact on the pattern of borrowing by the banks. In other words, in situations of increased repo rate, the banks need to pay higher interest to RBI in order to avail funds, while in terms of lower repo rate, the cost of borrowing funds is less.

The following scenarios discuss the impact of the repo rate on the economy.

1. When the inflation rate is high: At times of high inflation in the economy, the central bank (RBI) regulates the flow of money in the economy by increasing the repo rate, which results in fewer borrowings by the businesses and the industries. The result of this increase is slowing down the money supply and investment activities in the economy, which is instrumental in controlling the inflation rate.
2. To increase liquidity in the economy: When there is a requirement of increasing liquidity in the market, RBI eases the repo rate so that businesses can borrow money for investment purposes, which results in an increased money supply in the economy. The effect of such a step is that it becomes instrumental in the growth of the economy.

Scenarios that lead to an increase or decrease in the repo rate are as follows:

Increase in Repo Rate

1. When there is a high inflation rate in the economy, and as per RBI, the condition may further surge.
2. When there is a risk of depreciation of the currency
3. When it wants to reduce any speculations that arise in areas of foreign exchange
4. The possibility of the formation of asset bubbles as a result of an excessive amount of capital formation

Decrease in Repo Rate

1. That situation in which RBI assumes that both inflation and the fiscal deficit are well controlled and there is no unlikely possibility that a demand-led price surge will be observed.
2. When the economy is showing signs of slow down and RBI looks to accelerate the economy by facilitating a more friendly monetary policy.
3. If the balance of payments situation is deemed to be normal by the RBI.

Reverse Repo Rate: This is the rate the central bank of a country pays its commercial banks to park their excess funds in the central bank. Reverse repo rate is also a monetary policy used by the central bank (which is RBI in India) to regulate the flow of money in the market.When in need, the central bank of a country borrows money from commercial banks and pays them interest as per the reverse repo rate applicable. At a given point in time, the reverse repo rate provided by RBI is generally lower than the repo rate. While repo rate is used to regulate liquidity in the economy, reverse repo rate is used to control cash flow in the market. When there is inflation in the economy, RBI increases the reverse repo rate to encourage commercial banks to make deposits in the central bank and earn returns. This in turn absorbs excessive funds from the market and reduces the money available for the public to borrow.

Impact of Reverse Repo Rate on Economy

• The reverse repo rate has an impact on the economy as when the reverse repo rate is increased banks deposit their surplus funds with RBI in order to gain interest.
• The result is that the economy experiences reduced money flow, the banks find it more feasible to deposit the money in the central bank rather than providing it to individuals or businesses which results in boosting the value of the rupee.
• Similarly, inflation is controlled by RBI by increasing the reverse repo rate, and when the situations are perfect for increasing the inflation, RBI then cuts the reverse repo rate and repo rate so as to inject liquidity into the economy.
• The impact of change in reverse repo rate can be seen in home loans, as an increased reverse repo rate will encourage banks to invest their surplus funds in low-risk government securities instead of providing credit to individuals.
• It causes home loans to become dearer, while the opposite effect is seen when the reverse repo rate is decreased.

SLR: Statutory liquidity ratio or SLR refers to the minimum percentage of deposits that needs to be maintained by commercial banks in the form of liquid assets, cash, gold, government securities, etc. SLR is essentially a portion of the bank’s Net Demand and Time Liabilities (NDTL) or total demand deposits and time-based deposits. The limit of SLR for commercial banks is decided by the central bank of the country (Reserve Bank of India or RBI in India) but the deposits are maintained by the respective banks themselves. However, the SLR cannot be used by the bank for lending. The deposits designated towards SLR are eligible for earning interests. This monetary policy of the RBI is aimed at ensuring the solvency of the banks or ensuring that the banks, at any point in time, are capable of paying back their liabilities. This in turn ascertains that the depositor’s money is safe and helps in increasing their confidence in the bank. SLR is used to regulate inflation and maintain cash flow in the economy. When there is inflation, RBI increases the SLR to restrict the lending capacity of the bank. And when there is a need to infuse cash into the system, RBI reduces the SLR to help banks offer loans at better rates and improve borrowings.

CRR: Cash reserve ratio or CRR is a portion of a commercial bank’s total deposits that needs to be maintained at the central bank of the country (which is RBI in India). Just like SLR, the limit of CRR to be maintained is also determined by RBI. However, here the deposit is in the form of liquid cash and has to be kept in an account with the RBI.Banks are not allowed to utilise the CRR deposited for giving out loans or for other lending purposes. Apart from that, CRR deposits are also not eligible for earning interests. CRR helps in ensuring that the bank always has enough cash to disburse when depositors need it.The purpose of this monetary policy is to check inflation in the economy. When CRR is increased, the cash reserves of commercial banks are depleted which limits their lending capacity. This reduces borrowings and helps in controlling inflation.

MSF or marginal standing facility is a system of the Reserve Bank of India that allows scheduled commercial banks to avail funds overnight. The interest rate charged by RBI on such borrowings is called the MSF rate or marginal standing facility rate. RBI has introduced this provision to help scheduled banks when inter-bank liquidity completely dries up and they are in urgent need of money. MSF is sanctioned against government securities and the MSF rate is around 100 basis points or one percent higher than the repo rate. These loans fall under RBI’s liquidity adjustment facility or LAF. The maximum amount that can be availed under MSF is a percentage of the bank’s NDTL or net demand and time liabilities. Banks can use their SLR or statutory liquidity ratio to take loans under MSF. This is a short-term loan used to maintain the liquidity of banks. MSF helps in reducing the volatility of overnight lending rates and helps banks manage situations where there is a short-term asset liability mismatch. RBI uses this monetary policy to regulate the supply of funds into scheduled banks and also ensures safety for the depositors. Though limited, but the MSF rate at which banks borrow money from RBI can also affect retail loans. Generally, loans rates available for the public tend to get cheaper when MSF rate decreases and vice versa. Moreover, RBI also revises the MSF rate to strengthen the value of rupee, when required. Monetary standing facility was introduced by the RBI as a provision for banks to avail overnight funds during a revision of the country’s monetary policy in 2011-12.