What is repo rate, reverse repo MSF?

Q: Newspaper and television channels tend to throw a lot of terms around and people often do not understand exactly the key rate that we are talking about is just define for viewers what we mean by the repo rate, reverse repo when we refer to the overnight rate as also this concept of the marginal standing facility or the MSF?

A: I think the main point here is that the interest rate setting, there are multiple interest rates. For all practical purposes we should be focusing on the overnight rate which is the rate at which the banks borrow on an overnight basis. This overnight rate can fluctuate between the repo and the reverse repo rate.

Reverse repo is the rate at which when banks have excess funds they can park that money with the Reserve Bank of India and the interest rates that the Reserve Bank of India pays to the banks for parking their excess money is the reverse repo rate.

The opposite of reverse repo is really the repo rate. When banks do not have excess money supply then can borrow money from Reserve Bank of India under the repo rate. This borrowing is not free. Banks have to pledge their holding of government bonds as collateral and in turn borrow from the Reserve Bank of India.

There is another dimension to the monetary policy which has become effective since July of 2013 which is the marginal standing facility rate. When banks don't have excess collateral which is basically the government bonds to borrow from the Reserve Bank of India, as one knows banks have to maintain ex-percent of their deposits as collateral in government securities, this is called the statutory liquidity ratio. If they have excess government bonds over and above the SLR which is currently around 23 percent then they can borrow from the Reserve Bank of India under the repo window.

But in case some banks don't have excess SLR securities they can still draw down on their holding of SLR securities and borrow from the Reserve Bank of India at the marginal standing facility rate. So, this is a penal rate at which Reserve Bank of India supplies funds but this penal rate currently is almost 200 basis point above the repo rate. In order to understand with how the Reserve Bank of India's monetary policy is behaving the key operative instrument to focus is on the repo rate and overnight rate is the essential policy rates through which the Reserve Bank of India ensures that its monetary policy if is effective, so these are the two rates we should be focusing on, the repo rate and the overnight rate.