Economy
Reverse Repo Rate
Reverse Repo Rate is the interest rate at which the Reserve Bank absorbs liquidity from banks against the collateral of eligible government securities under the Liquidity Adjustment Facility (LAF).
How Reverse Repo Rate Works
- Banks provide funds to RBI → RBI provides eligible securities → RBI repays the funds with interest at the Reverse Repo Rate → Banks return the securities.
Reverse Repo Rate as a Monetary Policy Tool
- To Absorb Excess Liquidity: RBI can increase the reverse repo rate, making it more attractive for banks to park surplus funds with the RBI. This reduces liquidity available in the banking system.
- To Encourage Lending: RBI can lower the reverse repo rate, making it relatively less attractive for banks to park surplus funds with the RBI and encouraging deployment of funds elsewhere, including lending.
Impact of Reverse Repo Rate on the Economy
- Controls Inflation: A higher reverse repo rate encourages banks to park more surplus funds with the RBI → liquidity in the banking system declines → availability of credit tends to decline → aggregate demand moderates → inflationary pressure reduces.
- Regulates Liquidity: During periods of excess liquidity, a higher reverse repo rate helps the RBI absorb surplus funds from the banking system.
- Influences Credit and Economic Activity: A higher reverse repo rate makes parking surplus funds with the RBI relatively more attractive, tending to reduce funds available for lending. A lower reverse repo rate has the opposite effect.
Standing Deposit Facility (SDF)
- In April 2022, the RBI introduced the Standing Deposit Facility (SDF) as the primary tool to absorb excess liquidity.
- Difference: Unlike the Reverse Repo Rate, the SDF allows the RBI to absorb liquidity from banks without providing government securities as collateral.
- Current Status: The SDF replaced the fixed rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor.
