Which one of the following is not correct about Repo rate?
- (a)It is the interest rate charged by the Central Bank on overnight loan.
- (b)It is the interest rate paid by the commercial banks on overnight borrowing.
- (c)It is the interest rate agreed upon in the loan contract between a commercial bank and the Central Bank.
- (d)It is the cost of collateral security.
Correct — D, It is the cost of collateral security. The repo rate is a price for money, not a price for the security pledged against it. In a repurchase transaction a bank sells government securities to the Reserve Bank and agrees to buy them back a short while later at a slightly higher price; the difference, expressed as an annual rate, is the repo rate. The securities are the collateral, and their own cost — what the bank paid for them, or what they are worth in the market — has nothing to do with the rate. The other three options describe the same transaction from three angles: the rate the central bank charges, the rate the commercial bank pays, and the rate written into the agreement between them. All three are true of it; only the collateral claim is not.
- (a)It is the interest rate charged by the Central Bank on overnight loan. — Correct, so not the answer. The Reserve Bank lends short-term funds to commercial banks at the repo rate, which makes it the rate the central bank charges.
- (b)It is the interest rate paid by the commercial banks on overnight borrowing. — Correct, and it is simply option (a) read from the other side of the table. The rate the central bank charges is the rate the borrowing bank pays.
- (c)It is the interest rate agreed upon in the loan contract between a commercial bank and the Central Bank. — Correct. The rate is the one fixed in the repurchase agreement between the borrowing bank and the Reserve Bank, so describing it as the contracted rate is fair.
The repo rate is the policy rate of the Reserve Bank of India, set by the Monetary Policy Committee. It anchors the liquidity adjustment facility: banks short of funds borrow at the repo rate against government securities, and banks with surplus funds park them with the Reserve Bank at the floor of the corridor. A rise in the repo rate raises the cost of funds for banks and, through them, for borrowers, which is how monetary tightening is transmitted.
Two things about this item deserve to be said plainly. First, the answer is unambiguous: collateral cost is simply not what the rate measures. Second, options (a), (b) and (c) are loose descriptions rather than textbook definitions — a repo is technically a sale-and-repurchase agreement rather than a loan, and repo operations are not all overnight, since the Reserve Bank runs term repos of longer tenor too. The key treats them as correct because they capture the substance of the transaction, and the question only asks which one is not correct. Present-day note on the corridor: since April 2022 the floor of the liquidity adjustment facility has been the standing deposit facility rate, which replaced the fixed reverse repo rate in that role.
- The repo rate is the rate at which the Reserve Bank lends short-term funds to commercial banks against government securities.
- The securities pledged are the collateral; the repo rate prices the money, not the collateral.
- It is the policy rate under the liquidity adjustment facility and is decided by the Monetary Policy Committee.
- The standing deposit facility rate, introduced in April 2022, replaced the fixed reverse repo rate as the floor of the corridor.
- Raising the repo rate raises banks' cost of funds and tightens credit; lowering it does the reverse.
- Reading collateral into the rate; the securities secure the transaction but do not set its price.
- Assuming every repo is overnight — the Reserve Bank also conducts term repos.
As a which-statement-is-not-correct item on a policy rate, or as a statement-set pairing the repo rate with another instrument.
Consider the following statements: 1. The repo rate is the rate at which other banks borrow from the Reserve Bank of India. 2. A value of 1 for the Gini Coefficient in a country implies that there is perfectly equal income for everyone in its population. Which of the statements given above is/are correct?
- (a) 1 only
- (b) 2 only
- (c) Both 1 and 2
- (d) Neither 1 nor 2
Answer(a) 1 only
The same definition, stated positively and keyed as correct: the repo rate is the rate at which other banks borrow from the Reserve Bank. That is the sentence which makes the collateral-cost description in the CDS item impossible.
Consider the following statements regarding instruments of monetary policy: 1. Standing deposit facility (SDF) rate was introduced in April 2022. 2. SDF rate replaced fixed reverse repo rate as the floor of the LAF corridor. Which of the statements given above is/are correct?
- (a) 1 only
- (b) 2 only
- (c) Both 1 and 2
- (d) Neither 1 nor 2
Answer(c) Both 1 and 2
The same corridor four years on. The repo rate is still the policy rate, but the floor beneath it changed in April 2022, which is the update a student working from a 2020 paper needs.
- practice — not a real PYQ
In a repo transaction with the Reserve Bank of India, what does a commercial bank pledge?
- (a)Its own equity shares
- (b)Government securities
- (c)Corporate bonds of any rating
- (d)Foreign currency deposits
Answer(b) Government securities — the bank sells them to the RBI and agrees to buy them back, which is what makes the transaction a repurchase agreement.
- practice — not a real PYQ
An increase in the repo rate by the Reserve Bank of India is likely to
- (a)reduce the cost of funds for commercial banks
- (b)raise the cost of funds for commercial banks and tighten credit
- (c)have no effect on lending rates
- (d)increase the money supply immediately
Answer(b) raise the cost of funds for commercial banks and tighten credit — this is the main channel of monetary transmission.