Which of the following statements is/are correct?

1. Repo rate and Reverse Repo rate form part of Liquidity Adjustment Facility.

2. Reverse Repo rate is always lower than the Repo rate, for it is the rate at which the Reserve Bank of India (RBI) borrows.

3. An increase in the Reverse Repo rate will decrease the money supply and vice-versa.

Select the correct answer using the code given below:

Repo Rate: The rate of interest the Reserve Bank of India (RBI) charges from its clients on their short-term borrowing is the repo rate in India. Basically, this is an abbreviated form of the ‘rate of repurchase’ and in the western economies it is known as the ‘rate of discount’.

In practice, it is not called an interest rate, but considered a discount on the dated government securities, which are deposited by the institutions to borrow for the short term. When they get their securities released from the RBI, the value of the securities is lost by the amount of the current repo rate. The Call Money Market of India (inter-bank market) operates at this rate and banks use this route for overnight borrowings. This rate has direct relation with the interest rates banks charge on the loans they offer (as it affects the operational cost of the banks). The rate was 6 per cent in March 2018.

Reverse Repo Rate: It is the rate of interest the RBI pays to its clients who offer short-term loan to it.

It is reverse of the repo rate and this was started in November, 1996, as part of the Liquidity Adjustment Facility (LAF) by the RBI. In practice, financial institutions operating in India park their surplus funds with the RBI for short-term period and earn money. It has a direct bearing on the interest rates charged by the banks and the financial institutions on their different forms of loans. This tool was utilised by the RBI in the wake of over money supply with the Indian banks and lower loan disbursal to serve twin purposes of cutting down banks losses and the prevailing interest rate. It has emerged as a very important tool in direction of following cheap interest regime — the general policy of the RBI since the reform process started.

An increase in the reverse repo rate will decrease the money supply and vice-versa, other things remaining constant. An increase in the reverse repo rate means that commercial banks will get more incentives to park their funds with the RBI, thereby decreasing the supply of money in the market.

Both, repo rate and reverse repo rate form part of the Liquidity Adjustment Facility.

While repo injects liquidity into the system, reverse repo absorbs the liquidity from the system. RBI only announces repo rate. The reverse repo rate is linked to repo rate and is 100 basis points (1%) below the repo rate.