Repo Rate vs Reverse Repo Rate
Market participants in a funding market have both long-term and short-term funding requirements necessary to meet their financing requirements. Among the sources of funding available in the short-term money market are repurchase agreements or repos and reverse repurchase agreements or reverse repos. Repo Rate vs Reverse Repo Rate can essentially be viewed as two sides of a collateralized loan wherein the collateral posted could be fixed-income security as well as equity. These agreements are more common among firms dealing in government securities.
The repo rate is interest rate in a repo or repurchase agreement. A repurchase agreement involves borrowing money against some security posted with the lender. It involves two transactions: the first one being an outright sale of the specified securities and a simultaneous agreement to repurchase the same securities from the purchaser at an agreed price at a specified future date. Thus it is like a collateralized loan and usually attractive to the fund borrower owing to a low borrowing rate and high liquidity.
The reverse repo rate is the interest rate in a reverse repo or reverse repurchase transaction. A reverse repurchase agreement involves lending money against some security posted as collateral with the lender. It involves an outright purchase of the collateral with a simultaneous agreement to sell the same collateral at a future specified date at a price agreed with the borrower of money. It is a secured deposit for the lender of funds providing him with a short-term investment opportunity and could also provide an avenue of borrowing security for covering short positions.
Monetary authorities establish their policy rates through Repo Rate vs Reverse Repo Rate transactions. These are important tools for a country’s monetary authority to ensure price stability in the economy.
Head To Head Comparison Between Repo Rate vs Reverse Repo Rate (Infographics)
Below is the top 6 difference between Repo Rate vs Reverse Repo Rate
Key Differences Between Repo Rate vs Reverse Repo Rate
Both Repo Rate vs Reverse Repo Rate are popular choices in the market; let us discuss some of the major Difference Between Repo Rate vs Reverse Repo Rate
- Repo rate is the interest rate in a repo transaction which involves outright selling of securities with a commitment to buy back at a specified future date in the money market while reverse repo rate is the interest rate in a reverse repo transaction involving outright purchase of securities with a commitment to sell at a specified future date in the money market
- Principle users of repo rate transactions are securities market intermediaries, commercial banks, leveraged investors and monetary authorities while principal users of reverse repo transactions are commercial banks, monetary authorities, international financial institutions, money market mutual funds, sovereign wealth funds, pension funds, insurance companies, endowments, and corporate treasuries
- Repo rates offer the benefits of low short-term funding and high liquidity and are most suitable for securities market intermediaries who can free up funds by using the securities held in the course of their business. Reverse repo offer a short-term secured lending opportunity to cash-rich but highly risk-averse investors and may also be used for borrowing securities to cover short positions previously undertaken by the investors
- Monetary authority uses the repo rate to lend to the banking system and inject liquidity in the system with an objective to control inflation in the economy. Monetary authority uses the reverse repo rate to borrow from the banking system and simultaneously suck out excess liquidity from the system for controlling the money supply in the economy.
Repo Rate vs Reverse Repo Rate Comparison Table
Below is the topmost comparison between Repo Rate vs Reverse Repo Rate
|Basis comparison between Repo Rate vs Reverse Repo Rate||Repo Rate||Reverse Repo Rate|
|Meaning||The interest rate in a repo transaction which is a collateralized loan in the money market||The interest rate in a reverse repo transaction which is a secured deposit in the money market|
|Process||Short-term borrowing rate determined through outright sale of securities and the commitment to buy back the same securities on the specified future date||Short-term lending rate determined through outright purchase of securities and commitment to selling the same securities on the specified future date|
|Principal users||Securities market intermediaries like broker-dealers and investment banks, commercial banks, leveraged investors, monetary authorities etc.||Commercial banks, monetary authorities, international financial institutions, money market mutual funds, sovereign wealth funds, pension funds, insurance companies, endowments, and corporate treasuries|
|Benefit||A low rate of funding due to collateral involved and high liquidity, ideal for banks and broker-dealers holding securities in the course of their operations||Secured short-term lending rate for cash-rich but highly risk-averse investors since a collateral value is generally higher than the amount lent, may also be used to borrow securities for covering short positions|
|The perspective of the Monetary Authority||This is the short-term lending rate at which monetary authority lends to clients/banks against government securities; hence it is higher than the reverse repo rate fixed by the monetary authority and used by a country’s monetary authority to inject liquidity into the banking system and address deficiency of funds||This is the short-term borrowing rate at which monetary authority borrows from the clients/banks against government securities; hence it is lower than the repo rate fixed by the monetary authority and is used by the monetary authority to suck out excess liquidity from the banking system and control liquidity in the market|
|Use by the monetary authority||High repo rate by the monetary authority would signal higher official interest rate leading to higher lending rates in the economy, lower asset prices, exchange rate appreciation and fall in total demand thus putting downward pressure on inflation||An upward revision of reverse repo rate encourages banks to lend to the monetary authority leading to an upward revision of interest rates in the interbank market and decreasing money supply in the economy as market liquidity falls|
Conclusion – Repo Rate vs Reverse Repo Rate
Repo rates are the rates connected with repurchase agreements identical to a collateralized loan while reverse repo rates are the rates connected with reverse repurchase transactions identical to a secured deposit. Repurchase and reverse repurchase agreements are, in fact, two sides of the same agreement, former being from the perspective of the short-term fund borrower and later being from the perspective of a short-term lender. Usually while referring to these transactions with monetary authorities, the dealer’s perspective is taken into account for distinguishing the transaction between Repo Rate vs Reverse Repo Rate. Hence, repo rates set by monetary authorities are always higher than corresponding reverse repo rates.
Repo Rate vs Reverse Repo Rate are the most effective and direct tool used by the monetary authority to signal their policy rate stance. While repo rates are used for controlling inflation in the economy, reverse repo rates are used for controlling the money supply in the economy.
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