Difference between Repo Rate and MSF Rate

Definition of Repo Rate

The repo rate is the rate at which a nation's central bank, in this case, the Reserve Bank of India, loans money to commercial financial institutions in the event of a cash shortage. Monetary authorities use the repo rate to manage inflation.

Central banks raise the repo rate in an inflationary environment to discourage banks from borrowing from them. This lowers the amount of money in the economy, which aids in halting inflation. In the event that inflationary pressures decline, the central bank adopts the opposite stance. The facility for liquidity adjustments includes repo and reverse repo rates.

About Repo Rate

This refers to the interest rate at which a nation's central bank extends credit to private banks. The Reserve Bank of India (RBI), the nation's central bank, employs the repo rate to control the amount of liquidity in the economy. Repo rates in banking are associated with "repurchase agreements" or "repurchase options. "In times of financial scarcity, commercial banks obtain loans from the central bank, which they then repay based on the relevant repo rate. These short-term loans are offered by the central bank in exchange for securities like government bonds or treasury bills. The central bank uses this monetary policy to raise bank liquidity or manage inflation. When it becomes necessary to regulate prices and limit borrowing, the government raises the repo rate. Conversely, when additional money is needed to encourage economic expansion and replenish the market, the repo rate is lowered. A change in the repo rate would eventually have an impact on public borrowings such as home loans, EMIs, etc. because a rise in the rate implies commercial banks must pay more interest on the money borrowed from them. The repo rate indirectly affects a number of financial and investment instruments, from the interest rates that commercial banks charge on loans to the returns on deposits. The rate that a nation's central bank pays its commercial banks to store their surplus cash is known as the "reverse repo rate." Another monetary tool that the central bank (the RBI in India) uses to control the flow of money in the market is the reverse repo rate. When a nation's central bank is strapped for cash, it will borrow money from commercial banks & reimburse them with interest at the prevailing reverse repo rate. The reverse repo rate that the RBI offers is often less than the repo rate at any particular moment. Reverse repo rates are used to manage market cash flow, whereas repo rates are utilised to control liquidity in the economy. The RBI raises the reverse repo rate in an inflationary environment to entice commercial banks to deposit money with the central bank and earn interest. Consequently, this draws too much money from the market and lowers the amount of money that the general population can borrow.

Current Repo Rate

When commercial banks need money, they can borrow it at the repo rate, which is set by the central bank of the nation-in this example, the Reserve Bank of India, or RBI. Conversely, the interest rate that commercial banks receive when they loan money to the central bank or when they deposit surplus funds there is known as the reverse repo rate. The RBI's repo rate is 4% as of April 2021, while the reverse repo rate is 3.35%. In May 2020, the reverse repo rate was fixed at 3.35% and the repo rate was cut by 40 basis points, from 4.4% to 4%. In order to account for the current state of the economy, the RBI has maintained these important rates steady for the past five sessions. The RBI continuously adjusts the repo rate and reverse repo rate based on the status of the economy. Modifications to these interest rates impact every area of the economy. Most banks have what is known as an RRLR, or repo rate linked lending rate. The RBI directs banks to adjust the interest rates that apply to different loans in accordance with changes to the repo rate. Reductions in the repo rate typically result in lower interest rates on home loans, EMIs, and other loans, which makes it simpler for consumers to borrow money from banks or obtain loans. This in turn contributes to the nation's economic expansion. Although adjustments to repo rates are intended to impact commercial banks' interest rates, the actual rates that apply to a customer may differ between banks and depend on a number of other criteria, such as the loan's terms, which include the amount borrowed and the length of time it takes to repay it.

Meaning of Term Repo

"Repurchase option" or "repurchase agreement" is what repo stands for. This type of short-term borrowing enables banks and other financial institutions to borrow funds against government securities, with the understanding that they will repurchase the securities at a predetermined price (which is higher than the original sell price) after a predetermined amount of time. Banks can securely raise short-term cash by using repurchase agreements. These loans often last anywhere from one day to two weeks. Under this arrangement, the borrower signs a repurchase agreement (repo) while the lender signs a reverse repo (reverse repurchase agreement). The Reserve Bank of India, also known as the RBI, is the nation's central bank and lends capital to commercial banks at a rate of interest known as the repo rate. In order to help the banks meet their financial objectives, these loans are approved in return for securities. However, the RBI also offers banks the option to park their excess cash, in exchange for interest that is calculated using the reverse repo rate. The RBI will also pay this interest rate on loans from commercial banks. The RBI utilises reverse repo and repo to keep the nation's economy stable. By assisting commercial banks in borrowing money from the bank, the RBI injects money into the system whenever the economy needs a boost. Banks raise the funds required to expand their lending capacity through the use of repo. As a result, the bank will have adequate liquidity and the market will get money flow. However, the RBI employs reverse repo to take money out of the market and control the ability of commercial banks to lend money in the event of inflation.

RBI's Repo Rate

The interest rate at which Indian commercial banks borrow funds from the Reserve Bank of India is known as the repo rate. To obtain these loans through the nation's central bank, commercial banks must deposit securities like government bonds or just treasury bills as security. Usually, banks take these short-term loans when they are low on cash. When commercial banks deposit any surplus cash in the central bank, the RBI pays them a rate known as the reverse repo rate, which is similar to the repo rate. In general, the reverse repo rate is less than the repo rate. On April 7, 2021, the RBI declared during its bi-monthly monetary meeting that the reverse repo rate will remain at 3.35% and the current repo rate at 4%. These vital rates haven't been updated for the past five consecutive times. The reverse repo rate was set at 3.35%, and the repo rate was cut by 40 basis points, from 4.4% to 4%, in May 2020. The RBI uses the repo rate & reverse repo rate as monetary tools to preserve the nation's economic stability. Assume that the nation is experiencing a financial crisis. In order to encourage banks to borrow more and offer loans to the general public at lower interest rates, the RBI will, in this instance, lower the repo rate. In order to restrict the amount that commercial banks can borrow, the RBI will now raise the reverse repo rate if the nation's economy is facing inflation. Consequently, this will lower their ability to lend money and control inflation.

About MSF Rate

Scheduled commercial banks are able to obtain funds overnight through the Reserve Bank of India's MSF system. The MSF rate, also known as the marginal standing facility rate, is the interest rate that the RBI charges on certain types of borrowings. This measure was put in place by the RBI to assist scheduled banks in times of dire financial exigency when interbank liquidity fully dried up. The MSF rate is approximately 100 basis points, or one percent, higher than the repo rate, and it is sanctioned against government assets. The RBI's liquidity adjustment facility, or LAF, applies to these loans. A portion of the bank's net demand and time liabilities, or NDTL, is the maximum amount that can be obtained under the MSF programme. Banks may accept loans under MSF by using their statutory liquidity ratio, or SLR. Bank liquidity is preserved with the help of this short-term loan. A short-term asset liability mismatch can be managed by banks with the assistance of MSF, which also helps to lower the volatility of overnight lending rates. By implementing this monetary policy, RBI protects depositors and controls the flow of money into designated banks. Retail loans may also be impacted, however somewhat, by the MSF rate that is charged when banks borrow funds from the RBI. Publicly available loan rates typically decrease in tandem with a decline in the MSF rate. Additionally, when necessary, the RBI adjusts the MSF rate to support the value of the rupee. The RBI established the monetary standing facility in 2011-12 as a way for banks to obtain overnight funding while the nation's monetary policy was being revised.

Under the Marginal Standing Facility (MSF), scheduled commercial banks may draw down on their Statutory Liquidity Ratio (SLR) portfolio to the extent permitted by law in order to borrow additional overnight funds from the central bank beyond what is made available to them through the LAF (liquidity adjustment facility) window.

Facts about MSF

• Under the LAF (liquidity adjustment facility), banks obtain loans from the RBI by guaranteeing government bonds at a rate higher than the repo rate.
• One percentage point, or 100 basis points, is added to the repo rate to determine the MSF rate.
• Banks may borrow up to 1% of their net demand as well as liabilities (NDTL) under MSF.
• Banks are able to borrow through MSF Monday through Friday, except Saturdays.
• RBI accepts applications for a minimum of one crore rupees and then in multiples of that amount.
• MSF acts as a safety valve to protect the banking system against unforeseen shocks to liquidity.

MSF Rate's Impact

The MSF's consistent maintenance at a rate 100 bps higher than the repo rate is one of its key characteristics. MSF serves mainly as a noticeable buffer against liquidity. An increase in the MSF rate makes borrowing more expensive for scheduled banks, which in turn affects corporate and individual borrowers alike. The RBI uses MSF to manage the nation's money supply.

In order to combat the economy's rising inflation, the Reserve Bank of India raised the repo rate by 0.25%, or 25 basis points, on August 1st in its third bi-monthly monetary policy announcement of 2018. In the subsequent bi-monthly policy statement of the RBI for the fiscal year 2018-19, the lending rate was earlier increased by 25 basis points on June 6 from 6% to 6.25%. The most recent increase from 6.50% to 6.75% has also resulted in an increase in the MSF.

When was MSF first launched, and why?

The Reserve Bank of India implemented MSF in its 2011-12 Monetary Policy, which went into effect on May 9, 2011. This option was first made available in June 2011, and in the first year of its introduction, the banks borrowed a total of Rs. 1 billion under this policy. In order to improve the stability of overnight lending rates among banks and support appropriate financial transmission within the banking system, the most recent liquidity adjustment facility was implemented. It aided the RBI in improving its control over the flow of funds into the Indian financial system.

How Does MSF Operate?

Under the Liquidity Adjustment Facility (LAF), commercial banks guarantee the RBI that they will offer funds at a rate higher than the Repo rate when they are in extreme need of cash. The MSF rate is typically 25 basis points, or 0.25%, higher than the repo rate. All scheduled banks under the RBI are able to use this tool to get funds up to 1% of their SLR securities or NDTL (net demand and time liabilities) in times of emergency. Banks may only commit this exceptional capacity in an emergency situation if there is a total freeze in interbank liquidity.

Does the MSF Rate Increase Impact the Borrowers?

The RBI raises the MSF rate for a number of reasons, the most important of which are:

In order to control the rupee's excess supply inside the Indian banking sector. In an effort to halt the rupee's depreciation against the US dollar.

Indeed, borrowers are impacted in some way by the increase in the MSF rate. The rise in the MSF rate makes borrowing costly for banks, which in turn makes loans costly for borrowers because of the low obtainability of the rupee. You may find it challenging to obtain loans when you need them because of the high-interest rates on all loans-personal, home, or auto.

Why Did the RBI Recently Lower the MSF Rate?

On October 4, 2017, the Reserve Bank of India (RBI) reduced the monthly savings rate from 7.0% to 6.25%. By taking this action, the RBI is enabling banks to choose to deposit more money, which will improve the rupee's availability on the financial market. Banks can lend large sums of money to corporations and enterprises when they have enough money, which will support the growth of the Indian economy.

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