Every time the Reserve Bank of India reviews the monetary policies, you will hear about the repo and reverse repo from various stakeholders, including analysts, industries, and banks. When you delve into the meaning of what is repo rate and reverse repo, you will get the concept of the policy rate. In other words, the repo rate is nothing but the different rate at which the Reserve Bank of India offers money to certain banks in a shortage of funds. These are usually overnight and short-term borrowings. While doing this, one uses government securities. The Reserve Bank of India buys the Government bonds from various banks in shortage of finance and sells them back to the other banks at a fixed rate.
When the Reserve Bank of India tends to reduce the repo rate, the bank will get money at a cheap rate. When the RBI increases the repo rate, then borrowing from such banks becomes an expensive affair. It affects the final consumer of credit that can be any individual borrower, business, or institution. The opposite of the repo rate is known as the reverse report. The reverse rate is when the Reserve Bank of India borrows financial assistance from various banks. The Reserve Bank of India takes the fund for a short term. After taking the fund, the RBI sells the governmental bond to various banks and promises to buy the bond from the banks. Whenever the bank has enough finance with them, the process of reverse repo allows such bank to deposit the exclusive fund with the Reserve Bank of India to earn interest.
Securing the repo
It is a form of collateralized lending. The securities pass on to the buyer from the seller and are later returned to the original owner after completing the agreement. The collateral used in this case is the US treasury securities. In addition to that, one can also use any agency securities, Government bonds, corporate bonds, mortgage-backed securities, or even equities as collateral securities. The value of the collateral security tends to be greater than the price at which you purchase the security. At the date specified in the contract, the seller should repurchase these securities at the agreed rate. If there is any price difference, the seller might have to fund a margin account to assist the buyer financially.
Reverse repo agreement
In the reverse repo agreement, the dealer tends to sell all the securities to any counterparty. However, the dealer has the agreement to purchase them at a higher price. By doing this, the dealer raises the short-term funds at a favorable interest rate. It comes with little risk of going through loss. The transaction gets completed with the process of the reverse repo. In this process, one earns a lot of interest on the transaction as it sells the securities to the dealer at a higher price. Also, the counterparty can temporarily use the securities.
Special consideration
The main purpose of the report is to allow the borrower to borrow money. But one may confuse it with the loan. Ownership of the securities passes between the two parties that are involved in the process. These are short-term transactions that guarantee repurchase. One can term the repo rate vs. reverse repo rate as collateralized landing due to the involvement of securities in the form of Government bonds. It acts as the collateral for the short-term agreement of the loan amount. Therefore balance sheets and financial statements agreements are stated in the deficit column or debt as loan.
