The reverse repo rate (RRR) is the opposite of the repo rate. It is the short-term borrowing rate at which commercial banks park their surplus funds with the Reserve Bank of India (RBI). The RBI uses this tool to manage liquidity in the banking system, particularly when there is excess money circulating.
How the Reverse Repo Rate Works?
Absorbing Excess Liquidity
- When the RBI feels that there is too much money in the banking system, it increases the reverse repo rate. This incentivizes banks to deposit their surplus funds with the RBI, earning a higher interest rate.
- By depositing money with the RBI, banks reduce the amount of funds available for lending to customers (such as individuals and companies), which helps to control inflation and manage liquidity.
Safe Investment for Banks
- Banks prefer to lend money to the RBI because it is a risk-free option compared to lending to the public or businesses, which carries credit risk. An increase in the reverse repo rate makes this option even more attractive.
Repo Rate vs. Reverse Repo Rate
- Repo Rate: The rate at which liquidity is injected into the banking system by the RBI. Banks borrow funds from the RBI at this rate by providing collateral.
- Reverse Repo Rate: The rate at which the central bank absorbs liquidity from the banks. Banks earn interest by depositing their surplus funds with the RBI at this rate.