Repo rate is like the discount rate offered by the central bank of a country who buys government securities from that country’s commercial banks. The buying however, will depend on the level of money supply it is maintaining in the country’s monetary system. If a country desires to expand its monetary supply, then its central bank reduces the repo rates to allow banks to swap their government security holdings for cash. If they want to contract the money supply, then they increase the repo rates. Ultimately, it is the central bank who decides (as influenced or sometimes dictated by the government) on their desired money supply and have the market determine the appropriate repo rate.
In its most simple terms, repo rate is the rate at which a country’s central bank lends its money to all the other banks. In South Africa for example, the repo rate is the rate at which The South African Reserve Bank (the SARB) lends money to all the other South African banks. These banks may be having a shortage of funds and the only way they can recover is if they borrow from The South African Reserve Bank (the SARB ).\
In essence, the central bank of a country is acting like a banker for all those other private and commercial banks. This is actually the last resort when these banks are in dire need of cash and need liquidity the soonest time possible. So, financial assets are sold temporarily by the banks as collateral for the cash they are borrowing and the whole system of borrowing and lending works primarily on give and take principle.
High and Low Repo Rates
When the central bank increases the repo rate, borrowing money from them becomes more expensive. These other banks would have to pay more in exchange for getting funds. Central banks do this to profit more and to balance the profit margins. But when the repo rate is reduced, that’s when borrowing becomes optimal for other banks because they can now borrow money at a much cheaper rate. The government alters the repo rate from time to time to control the availability of their money supply in the market. Doing so controls inflation in the process.
Here is a simple example: Let’s say that the repo rate is at 5.5%. If central bank increases the repo rate by 50 basis points, the new repo rate would be 6%.
How is inflation controlled?
When banks sell their securities to the central bank at a discount rate called the repo rate, they do so at a limited period. After the agreed amount of time, the banks can repurchase the bill at its face value. This means that high repo rates are the ones absorbing the liquidity from the bank to help lend more money to customers thereby helping control inflation.
The repo rates play an important role in the economy. It not only offers a financing solution to banks and helps curb the rising inflation, but it also helps dictate what the levels of money supply will be for that country.