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Explain How 'Repo Rate' Can Be Helpful in Controlling Credit Creation. - Economics

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Explain how 'Repo Rate' can be helpful in controlling credit creation.

Explain the role of Reverse Repo Rate in controlling credit creation.

Explain the role of reverse repo rate in controlling the money supply.

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Solution

Repo rate is the rate at which commercial banks can borrow money from RBI to overcome the shortage of money. By varying the repo rates, the RBI can increase or decrease the supply of money. This rate relates to the loan offered by RBI with securities and only short-term borrowings by the commercial banks.

Repo rate is used as the main instrument of credit control. When the Central Bank raises the repo rate, there will be an increase in the cost of borrowing which reduces commercial banks borrowing from the Central Bank. Consequently, the flow of money from the commercial banks to the public reduces. Therefore, the supply of money reduces and bank credit creation is controlled.

Concept: Repo Rate and Reverse Repo Rate
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