Basically, Repo is a repurchase agreement and refers to the rate at which commercial banks borrow money by selling their securities to the Central bank of our country, i.e. in case of shortage of funds or due to some statutory measures, Bangladesh bank have to maintain liquidity. It is one of the main tools of the Central Bank to keep inflation under control. Also known as a repo agreement, is a form of short-term borrowing, mainly in government securities.
The repo market is an important source of funds for
large financial institutions in the non-depository banking sector, which has
grown to rival the traditional depository banking sector in size. Large
institutional investors such as money market mutual funds lend money to
financial institutions such as investment banks, either in exchange for
collateral, such as treasury bonds and mortgage-backed securities held by
borrower financial institutions.
Reverse Repo Rate is a mechanism to absorb the
liquidity in the market, thus restricting the borrowing power of investors. Reverse
Repo Rate is when the Central Bank borrows money from a bank when there is
excess liquidity in the market. The banks benefit from it by receiving interest
on their holdings from the central bank.
An increase in the reverse repo rate will decrease
the money supply and vice versa, other things remaining constant. An increase in
reverse repo rate means that commercial banks will get more incentives to park
their funds with BB, thereby decreasing the supply of money in the market.
During
high levels of inflation in the economy, the Central Bank increases the reverse
repo. It encourages the banks to park more funds with the Central Bank to earn
higher returns on excess funds. Banks are left with lesser funds to extend
loans and borrowings to consumers.