What are Repo Rates and Reverse Repo Rates?
Repo is the short form of Repurchase Agreement which stands for an agreement for the Sale and Purchase of Securities where the seller will buy back the securities at a later date.
Repo Rate is the Difference between Repurchase Price and the Original Sale Price normalized over the period of time. It is equivalent to the Interest accrued by the Original Buyer on the Money he spent during the Sale of Securities.
Lets make it clear that, Security is a financial term representing a Tradable asset of any kind. It is are broadly categorized into:
Debt securities (such as banknotes, bonds and debentures)
Equity securities, e.g., common stocks
Derivative contracts, such as forwards, futures, options and swaps.
The Repo is equivalent to Loan in many aspects. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of interest. This Interest Rate is Called Repo Rate.
A reverse Repo is simply the same repurchase agreement from the buyer’s viewpoint, not the seller’s. Hence, the seller executing the transaction would describe it as a “repo”, while the buyer in the same transaction would describe it a “reverse repo”.
This means “repo” and “reverse repo” are exactly the same kind of transaction, just being described from opposite viewpoints. If you parties A and B indulge in a Security Trade, the Repo Rate for A would be Reverse Repo Rate for B and vice versa. It merely represents the viewpoint.
In India, RBI uses repo and reverse repo techniques to increase or decrease the liquidity in the market. To increase liquidity, RBI buys government securities from banks under REPO; to decrease liquidity, RBI sells the government securities to banks.
The repo rate in India as of 21st Sept ’13 was 7.50% and the reverse repo rate which is 100 bps below the repo rate stood at 6.50%. Here these Rates represent RBI’s viewpoint.