reverse repo rate

RBI cuts repo, reverse repo rate by 50 bps

The Reserve Bank today (March 4) cut its key overnight lending and borrowing rates by 50 basis points each with immediate effect, signalling banks to further soften interest rates.

Since October, RBI has reduced key policy rates to fuel demand in the economy reeling under the impact of the global financial meltdown.

The repo, the rate at which RBI lends short-term funds to commercial banks, has been reduced from 9 per cent in October to 5 per cent now. Similarly, the reverse repo, the rate at which banks park overnight funds with RBI, has been brought down from 6 per cent to 3.5 per cent.

The decision, RBI said, “will further encourage banks to provide credit for productive purposes at viable interest rates. The Reserve Bank on its part would continue to maintain ample liquidity in the system.”

The decision to reduce key rates follows a review of the current global and domestic macro-economic situation, the RBI said.

Following the string of rate cuts by RBI, banks, especially state-owned, have reduced their lending and deposit rates considerably, but borrowing activities do not seem to have witnessed any major surge.

RBI Governor D Subbarao had earlier said there is room for further cut in policy rates.

Even though banks have cut lending rates in response to RBI’s policy stance, the central bank said in a statement that “concerns over rising credit risk together with the slowing of economic activity appear to have moderated credit growth.”

It further said that banks should ensure that creditworthy enterprises should continue to get funding.

(Agencies)

From Wikipedia, the free encyclopedia

A Repurchase agreement (also known as a repo or Sale and Repurchase Agreement) allows a borrower to use a financial security as collateral for a cash loan at a fixed rate of interest. In a repo, the borrower agrees to immediately sell a security to a lender and also agrees to buy the same security from the lender at a fixed price at some later date. A repo is equivalent to a cash transaction combined with a forward contract. The cash transaction results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is the interest on the loan while the settlement date of the forward contract is the maturity date of the loan.
Structure and terminology

A repo is economically similar to a secured loan, with the buyer receiving securities as collateral to protect against default. There is little that prevents any security from being employed in a repo; so, Treasury or Government bills, corporate and Treasury / Government bonds, and stocks / shares(it is not secured loans and have to be removed from repo securities list), may all be used as securities involved in a repo. However, the legal title to the securities clearly passes from the seller to the buyer, or "investor". Coupons (installment payments that are payable to the owner of the securities) which are paid while the repo buyer owns the securities are, in fact, usually passed directly onto the repo seller. This might seem counterintuitive, as the ownership of the collateral technically rests with the buyer during the repo agreement. It is possible to instead pass on the coupon by altering the cash paid at the end of the agreement, though this is more typical of Sell/Buy Backs.

Although the underlying nature of the transaction is that of a loan, the terminology differs from that used when talking of loans because the seller does actually repurchase the legal ownership of the securities from the buyer at the end of the agreement. So, although the actual effect of the whole transaction is identical to a cash loan, in using the 'repurchase' terminology, the emphasis is placed upon the current legal ownership of the collateral securities by the respective parties.

The following table summarizes the terminology:
Repo Reverse repo
Participant Borrower
Seller
Cash receiver Lender
Buyer
Cash provider
Near leg Sells securities Buys securities
Far leg Buys securities Sells securities