Repo and Reverse Repo rates

Recently RBI hiked the repo rates and reverse repo rates by 25 basis points. This is done to keep the inflation under control. The other side effect of it is the increase in home loan rates. Currently the fixed loan rate is around 10% and the floating rate is around 8-9%, with the repo rates increasing, the interest rates will also go up. Some estimates the fixed rate to touch the 11%, while the floating rate might reach the 9-10% mark.

A repo is a repurchase agreement transaction that involves using a security as collateral for a loan. At the inception of the transaction, the dealer lends the security and borrows funds. When the transaction matures, the loan is repaid and the security is returned.

Repo rate: The rate of interest to be paid on a repo loan.

This picture is taken from Federal Reserve Bank of Atlanta E C O N O M I C R E V I E W Second Quarter 2002

The reverse repo rate is the rate at which the RBI borrows or absorbs excess funds from banks. And the repo rate is the rate at which banks can borrow money quickly from RBI. If the repo rate is increased, it makes difficult for banks to borrow quick short-term money from RBI, thus reducing the cash-in-hand capability of banks. With less cash with banks, they would want to lend it to the people for home or car loans at higher interest rates, so that they get protected against the reduction in funds.

Also with a increased reverse repo rate, RBI becomes the best borrower and hence all the banks would want to lend the money to RBI, which again causes a shortage of liquid funds in the market. Thus repo rates and reverse repo rates have become an important monetary policy instrument for RBI.

PS: Home Loans Hike by banks

Floating rate for HDFC home loans will be 9.5 per cent as against 9 per cent earlier, while the new fixed rate will be 11 per cent from 10.5 per cent. ICICI Bank, SBI indicated that they will wait and watch before taking any call on increasing rates.