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Reverse Repo Rate

Introduction

Reverse Repo Rate is a crucial monetary policy concept that explains how the Reserve Bank of India (RBI) absorbs excess money from the banking system. It is frequently tested in banking exams through direct definitions and comparison-based questions.

Understanding reverse repo rate helps you clearly link liquidity control with RBI’s inflation management strategy.

Pattern: Reverse Repo Rate

Pattern

Reverse Repo Rate is the interest rate at which the Reserve Bank of India borrows short-term money from commercial banks by offering government securities.

Step-by-Step Example

Question

What is the most likely impact when RBI increases the reverse repo rate?

Options:

  • A. Banks lend more money to the public
  • B. Liquidity increases in the economy
  • C. Banks deposit more funds with RBI
  • D. Inflation rises sharply

Solution

  1. Step 1: Understand reverse repo rate movement

    An increase in reverse repo rate means RBI offers a higher return to banks for parking their surplus funds.

  2. Step 2: Analyse banks’ response

    Higher returns encourage banks to deposit excess money with RBI instead of lending it in the market.

  3. Step 3: Connect with liquidity

    When banks park more funds with RBI, liquidity in the economy reduces.

  4. Final Answer:

    Banks deposit more funds with RBI → Option C

  5. Quick Check:

    Reverse Repo ↑ → Banks park funds with RBI → Liquidity ↓ ✅

Quick Variations

• Reverse repo rate hike → liquidity absorption by RBI.

• Reverse repo rate cut → banks prefer lending → liquidity increases.

• Reverse repo is always lower than repo rate.

Trick to Always Use

  • Step 1 → Reverse Repo = RBI borrows from banks
  • Step 2 → Reverse Repo ↑ = banks park money with RBI
  • Step 3 → Reverse Repo ↓ = liquidity increases

Summary

Summary

  • Reverse Repo Rate is the rate at which RBI borrows short-term funds from banks.
  • It is used to absorb excess liquidity from the banking system.
  • An increase in reverse repo rate reduces money supply in the economy.
  • A decrease in reverse repo rate encourages banks to lend more.

Example to remember:
Reverse Repo ↑ → Banks save with RBI → Liquidity ↓

Practice

(1/5)
1. Reverse Repo Rate is the rate at which banks lend money to which institution?
easy
A. Reserve Bank of India
B. Government of India
C. Other commercial banks
D. Public sector undertakings

Solution

  1. Step 1: Recall the definition of Reverse Repo Rate

    Under reverse repo, banks lend their surplus funds.

  2. Step 2: Identify the borrowing authority

    The borrowing institution is the central bank.

  3. Final Answer:

    Reserve Bank of India → Option A

  4. Quick Check:

    Reverse repo = Banks lend to RBI ✅
Hint: Reverse repo always means banks → RBI.
Common Mistakes: Confusing reverse repo with inter-bank lending.
2. Which of the following best explains why banks use the reverse repo facility?
easy
A. To meet long-term funding needs
B. To earn interest on surplus funds
C. To avoid statutory requirements
D. To increase credit risk

Solution

  1. Step 1: Identify banks’ situation

    Banks may have excess short-term funds.

  2. Step 2: Link reverse repo with returns

    RBI pays interest on money parked under reverse repo.

  3. Final Answer:

    To earn interest on surplus funds → Option B

  4. Quick Check:

    Surplus funds + interest = Reverse repo ✅
Hint: Banks park extra money with RBI to earn interest.
Common Mistakes: Assuming reverse repo is for emergency borrowing.
3. Reverse repo rate mainly helps RBI to manage which of the following?
easy
A. Fiscal deficit
B. Foreign exchange reserves
C. Excess liquidity
D. Capital adequacy

Solution

  1. Step 1: Recall RBI’s objective

    Reverse repo is used when too much money is in the system.

  2. Step 2: Identify the controlled factor

    It absorbs excess liquidity from banks.

  3. Final Answer:

    Excess liquidity → Option C

  4. Quick Check:

    Reverse repo = liquidity absorption tool ✅
Hint: Reverse repo removes extra money from the system.
Common Mistakes: Linking reverse repo to fiscal management.
4. Which of the following correctly compares repo rate and reverse repo rate?
medium
A. Both are long-term lending rates
B. Repo absorbs liquidity, reverse repo injects liquidity
C. Repo and reverse repo are always equal
D. Reverse repo is lower than repo rate

Solution

  1. Step 1: Recall rate hierarchy

    Repo rate is the main policy rate.

  2. Step 2: Compare the two rates

    Reverse repo is kept lower to discourage excess parking.

  3. Final Answer:

    Reverse repo is lower than repo rate → Option D

  4. Quick Check:

    Repo > Reverse Repo always ✅
Hint: Reverse repo is always below repo.
Common Mistakes: Reversing the rate order.
5. A decrease in reverse repo rate is most likely to encourage banks to do what?
medium
A. Increase lending to the public
B. Park more money with RBI
C. Increase CRR balances
D. Reduce government securities holding

Solution

  1. Step 1: Understand reverse repo cut

    Lower reverse repo offers less return on parked funds.

  2. Step 2: Predict banks’ behaviour

    Banks prefer lending instead of parking money.

  3. Final Answer:

    Increase lending to the public → Option A

  4. Quick Check:

    Reverse repo ↓ → Lending ↑ → Liquidity ↑ ✅
Hint: Lower reverse repo pushes banks to lend.
Common Mistakes: Assuming banks will still park funds with RBI.

Mock Test

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