Reverse Repo Rate (Detailed)

The reverse repo rate sits at the lower bound of the RBI's Liquidity Adjustment Facility (LAF) corridor, with the repo rate forming the upper bound and the Standing Deposit Facility (SDF) rate now serving as the effective floor since April 2022. When commercial banks park surplus funds with the RBI under the LAF, they earn interest at the reverse repo rate, incentivising banks to lend this idle money to the RBI rather than pushing it into the credit market.

Historically, the reverse repo rate was set 25 basis points below the repo rate, creating a symmetric corridor. However, when the RBI introduced the SDF in April 2022, the corridor architecture shifted: the SDF rate replaced the fixed-rate reverse repo rate as the effective floor. Under the SDF, banks can park excess funds without receiving government securities as collateral — a departure from the conventional reverse repo mechanism. Nevertheless, the reverse repo rate remained notionally cited at 3.35 percent for an extended period as the SDF rate moved in tandem with repo rate changes.

The reverse repo rate gained considerable attention during the Covid-19 pandemic. Between March 2020 and May 2020, the RBI aggressively cut both the repo rate and the reverse repo rate, but it cut the reverse repo rate more sharply — by 90 basis points versus 40 basis points for the repo rate. This asymmetric cut widened the LAF corridor from 25 bps to 65 bps, deliberately discouraging banks from passively parking liquidity with the RBI and nudging them towards productive lending.

The reverse repo rate is distinct from the bank rate (which is a penal lending rate) and from the marginal standing facility rate (which allows banks to borrow above their SLR limits overnight). Whereas the repo rate signals the cost of borrowing from the RBI, the reverse repo rate signals the returns available to banks for depositing surplus funds, making it a tool to manage systemic liquidity rather than credit creation directly.

When liquidity in the banking system is in surplus mode — meaning banks are net lenders to the RBI — the reverse repo rate effectively becomes the operative policy rate that influences short-term market rates such as CBLO and overnight MIBOR. The call money rate tends to gravitate towards the reverse repo rate in surplus conditions. Analysts therefore watch the gap between the repo rate and the effective overnight rate as a proxy for system liquidity.

For equity investors, the reverse repo rate environment matters because prolonged surplus liquidity (with reverse repo as the operative rate) tends to keep borrowing costs low across the economy, supporting credit off-take, housing loan demand, and consumption spending. Conversely, a shift from surplus to deficit liquidity — where banks start borrowing from the RBI at the repo rate — signals tighter financial conditions and can compress net interest margins for banks that were benefiting from cheap deposit mobilisation.