AP (Advanced Placement) Macroeconomics Financial Sector-Banking Terms and Persons (Page 39 of 51)

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Repo Rate

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Repo rate is interest rate charged by the RBI on overnight loans given to the commercial banks under the Liquidity Adjustment Facility. The repo rates՚ 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. Repo rate is the interest rate anchorSignificance 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.

Repo or Repurchasing Option

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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.