Controlling Liquidity with Repo Rate and Reverse Repo Rate

Reserve bank controls repo rates and reverse repo rates as a measure of controlling liquidity and inflation. For commercial banks the major source of short term funding is Reserve Bank. Banks go short of money when there is a high demand for loans and the cash in hand at the banks is low. If RBI feels that the liquidity in the system is high and wants to make money more expensive it increases repo rate (The rate at which it lends to banks). Similarly if RBI feels there is a liquidity crunch in the market it reduces repo rate and hence the cost of money.

On the other hand when the liquidity in the system is very high RBI borrows money from banks by offering lucrative interest rate (reverse repo rate). Banks would prefer to keep their money with RBI as the default risk is zero. Liquidity is contained in this way.

Related posts

July 19, 2008 | Filed Under Bonds 

Comments

Leave a Reply





Add to Technorati Favorites