CRR, Repo Rate and Reverse Repo Rate - Meaning, Significance

By K Balaji|Updated : November 9th, 2022

CRR rate is essential and instrumental in gauging monetary policy. It keeps a check on the flow and circulation of the economy that impacts loans and investments. It also holds essentiality in times of inflation. The repo rate determines the money charged by the banks on the accreditation of loans. It is also referred to as a floating rate. The time period of repayment varies in accordance with the bond structure.

The reverse repo rate also influences the economy in a different way. This article facilitates complete knowledge regarding the CRR rate, repo rates, and reverse repo rates. These topics pick out to be an essential stratum of the UPSC syllabus. The candidates can get the complete details of the concept by walking through the essential details presented in this article. The significance of the CRR rate, repo rate, and reverse repo rate are considered to be essential in terms of questions asked in the UPSC exam.

Table of Content

CRR

The CRR rate expands for the Cash Reserve Ratio rate. It is an essential factor and parameter in monetary policy. It is the cash that is kept as a deposit in the banking sector for the prevention of running out of cash. The amount that is kept reserved either in the vault of the bank or sent to the Reserve Bank of India. In case of a low CRR rate, the money is circulated as loans, in numerous investments. In case the CRR rate surges it influences and impacts the economy in a negative way. The circulation of the economy also reduces and decelerates

Significance of CRR

There are numerous factors that determine the essentiality of the Cash Reserve Ratio. It plays an instrumental role in determining the circulation of money.

CRR, Repo Rate And Reverse Repo Rate UPSC PDF

  • It keeps a check on the specified amount of money that is reserved in the vaults of banks and is sent to the Reserve Bank of India.
  • In inflation the CRR rates surge, to regulate and control the circulation of money.
  • When money or funds are needed, the CRR rates are lowered to increase the circulation of money.

What is Repo Rate?

The term repo rate refers to the rates charged by the banks to borrow and lend money. When one goes to a bank and wants to borrow money, they agree with the bank, stating that they will repay the borrowed amount at a specific date (say, one month from now).

As such, the repo rate is usually a floating rate. The period for repayment is variable in tandem with bond maturities and other interest rates.

Significance of Repo Rate

First and foremost, this is the rate used to calculate the amortization of a bond. The annual interest rate on the bond minus the repo rate determines the annual accretion or amortization of a bond.

  • The interest is calculated daily for the initial 30 days, reaching its maximum amount on the 30th day.
  • From month 31 to maturity, the interest is calculated and compounded only at the end of each month.
  • The repo rate represents another primary benchmark to gauge inflation.
  • As such, it's often used as a reference rate for many kinds of investments and transactions that have to do with government-issued debt, such as Treasury bills and bonds, municipal securities, home mortgage loans, etc.

What is Reversed Repo-Rate?

The Reverse repo rate is facilitated to the banks by the Reserve Bank of India in case of lending money. This is the money charged by the commercial banks, this also keeps in check the money circulation in the country. The reverse repo rates also gauge inflation, as when the rates of reverse repo rate is lower the local banks deposit more money to the Reserve Bank of India, thus lowering the economy flow and loans.

Sometimes, even after one has completed the transaction and received cash or collateral, you might need to reverse your payment from the deal's proceeds. This is usually because the buyer disagrees with your agreed-upon terms.

This is where a reverse repo rate comes in. An institution that provides reverse-repo services will buy back your securities they had previously sold at a different price, compare that to what they originally bought them for, and then charge you a price in between those two prices known as a rate that is lower than what you originally paid for them. Alternatively, the reverse repo rate may be called an inverse repo rate.

Why Is Reverse Repo Rate Important?

If you're a long-term investor and are eager to buy something at a lower price than what you originally agreed upon with the bank but still want to get your money, a reverse repo rate may be more favorable to your options.

  • The reserve repo rates keep a check on inflation while the reverse repo rates are lowered the commercial banks reserve their money with the central banks. This restricts the economy flow, and lending of loans.
  • This is especially advantageous on government-issued bonds where they're often used as collateral against home mortgage loans, auto loans, and other more varied real estate transactions.
  • While reverse repo rates may not be a good choice for all types of investors, it's an option to consider when buying bonds and other securities deemed as suitable for collateralizing home mortgages.
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FAQs on CRR, Repo Rate and Reverse Repo Rate

  • The Cash Reserve Ratio is an essential stratum governing the flow of the economy and keeping a check on monetary policies. It assists the banks in the prevention of running out of cash. During inflation, the CRR rates surged to regulate the flow of the economy. In the case when money is needed, the CRR rates are lowered to increase the flow of the economy. The money is reserved in the vaults of the banks or deposited in the Reserve Bank of India.

  • The repo rate is the money charged by RBI while lending money to other banks. The repo rates regulate the flow of money and the economy. It is also referred to as a floating rate. The Reserve Bank of India regulates and decides the repo rates, reverse repo rates, and CRR rates.

  • The reverse repo rate is the money charged by commercial banks while lending to the Reserve Bank of India. In a nutshell, the banks receive incentives by reserving and depositing their money with the central bank. It also plays an essential role in controlling inflation rates.

  • The fall in the CRR rates increases the economic flow. Commercial banks get in hold of more cash that is used in lending and providing loans. It is also used in numerous investments. When CRR rate increases, the economic flow decelerates.

  • The financial markets' Repo Rate and Reverse Repo Rate are market-driven. They're based on the needs of banks and other financial institutions. Banks use repurchase agreements to bridge cash flow shortages while boosting their liquidity. For example, banks use reverse repo to generate funds from selling specific securities at a higher price than what they bought them for.

    In turn, the price paid for the security is compared with what it sold for originally to see if there's a difference in value. If there is, that difference is credited back to the bank's reserves which will be used for future operations and investments.

  • The Repo Rate and Reverse Repo Rate can affect investors in two ways. First, it's used as a reference rate for the amortization of bonds. Second, the repo rate is an inflationary indicator to help investors make sounder financial decisions.

  • A reverse repo rate is used when a bank needs to return an asset. On the other hand, a repo rate is used when a bank wants to borrow money from investors or other financial institutions.

  • The Repo Rate and Reverse Repo Rate in the financial markets operate on supply and demand. Supply is defined as the number of repo being offered by banks for sale or purchase at a given time. In contrast, demand is defined as the number of repo financed by banks, investors, or other financial institutions. This can change based on the economic conditions of an economy or country.

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