Let me clarify this idea in the most straightforward manner so that even a naive can understand. Banking and the financial exchange are fascinating organizations however the names given to their related terms appear to make it hard to comprehend. Repo and Reverse Repo are likewise one of them.
The idea of both are basic however market analysts have caused it to appear to be confused.
What is the significance of Repo and Reverse Repo rates?
Let us understand through a conversation between a dad and his teenage son.
Child: I have heard as of late RBI Governer has diminished Repo Rate by 50 premise focuses and everybody is stating this is useful for the market. Advance EMI may likewise descend. What is this rate cut methods really? I need to get this.
Father: To comprehend this you first need to know, how does a bank work.
Child: Why?
Father: Because all these are between related. Let me know – what does a bank do?
Child: Bank takes cash from contributors and offers credits to acquire premium. That way they keep everybody glad and make a benefit too.
Father: Correct, however there is something else entirely to it. Let me clarify this in a shortsighted manner. A bank needs cash. Bank can get cash from investors like you and me and furthermore from RBI. In any case, the bank additionally needs to pay certain enthusiasm to us and furthermore to RBI.
Child: Ok.
Father: Let us attempt to see first – what happens when we store, say, Rs. 100 with a bank.
Child: I realize that. Bank gives that Rs. 100 to somebody who needs a credit.
Father: No, it isn't unreasonably straightforward. Keep in mind, however the bank can win enthusiasm by parting with advances, it is likewise exceptionally dangerous. There are numerous instances of credit defaults. Along these lines banks can place all our cash into high-hazard regions. It must be ensured.
Child: How?
Father: Ok, RBI has made it required that after accepting, state, Rs. 100, banks initially need to store Rs. 4 with RBI. RBI keeps this Rs. 4 in its current a/c and henceforth banks don't get any enthusiasm on this cash. This is known as Cash Reserve Ratio or CRR, which is right now at 4%.
Child: Hmmm, at that point?
Father: RBI has additionally made it compulsory that after accepting, state, Rs. 100, banks need to necessarily purchase focal and state govt protections of Rs. 21.50. Obviously, banks will win some premium pay here. This is known as Statutory Liquidity Ratio (SLR), which is as of now at 21.50%.
Child: Ok, so you intend to state that after getting Rs. 100, banks can spend just Rs. 74.50 at its own will.
Father: Correct. 100 – (4 + 21.50) = 100 – 25.50 = 74.50
Child: But you were stating that banks can likewise get from RBI. What premium banks pay to RBI?
Father: Before 30th September 2016, banks were paying 8.25% enthusiasm to RBI when it acquired cash from RBI. Presently this rate has been decreased by 50 premise focuses. So banks presently need to pay enthusiasm to RBI, in the event that it acquires from RBI, at the pace of 7.75%. This is known as Repo Rate.
Child: Can fixed store rate be influenced by a decrease of Repo Rate?
Father: obviously. On the off chance that banks get cash from RBI @7.75%, for what reason will banks pay higher enthusiasm to you and me? One year FD rate is as of now amended by numerous banks and it is equivalent to or near 7%.
Child: But as now banks are getting cash at a less expensive rate, at that point they ought to decrease the advance loan fee for example passing on the advantages it gets.
Father: Correct. They should. What's more, on that expectation advertise is cheering. On the off chance that organizations get a credit at a less expensive rate, they will prone to grow their organizations. That will make more employments, more pay and lift the economy.
Child: How is expansion connected to this?
Father: See, when enthusiasm on an advance turns out to be less, individuals will in general obtain more. That implies individuals will have more cash to spend. This will expand the interest for merchandise, and on the off chance that the flexibly doesn't increment to coordinate this interest, at that point costs will increment.
Child: So there is an opportunity, that expansion may rise too?
Father: Well, yes. However, expansion relies upon numerous different factors too, similar to creation (modern and rural), producing, send out import, remote cash development and so on. So expansion may increment or may not.
Child: One last inquiry. Like we store our cash with banks, can banks likewise store their cash with somebody?
Father: Yes, they can store with RBI and acquire intrigue as well. This intrigue is regularly 1% not exactly the repo rate. This rate is known as the Reverse Repo Rate.
Child: Great! So now I comprehend CRR, SLR, Repo Rate, Reverse Repo Rate and their effect on store rate, credit financing cost and on swelling.
(End of discussion)