A repo rate is the rate of interest at which commercial banks borrow money, for short-term periods, from the central bank in a given country, for liquidity purposes. Lending, by means of a repo, is collateralized by a given type of securities (such as government bonds or treasury bills). Technically, a commercial bank sells its security holdings, in the tune of the required loan, to the central bank, while agreeing to repurchase these securities later on as set out in the contract. The difference between the repurchase price and the original sale price represents the repo return (or repo interest).

On the other hand, a reverse repo rate refers to the rate that is used in a reverse repo transaction. It is rate at which the central bank borrows money from market players, such as commercial banks within its jurisdiction. An increase in this rate means that the central bank is increasing the incentives for commercial banks to invest their surplus funds with the central bank, thereby decreasing the money supply in the market. In turn, a decreasing rate implies that these banks get lower incentives to deposit their funds with the central bank, thereby increasing the money supply in the market.

In short, a repo rate is a lending rate, while a reverse repo rate is a borrowing rate, from the standpoint of a central bank. Both are part of mechanism to influence the money supply in an economy and provide a basis for central banks’ transactions with the banking sector. For a repo rate, it is part of monetary tools to inject liquidity into the market, and as a rate it provide a benchmark for securitized, short-term lending cost within the sector. A reverse repo rate is part of central banks’ tools to absorb a certain amount of liquidity from the market and to signal off short-term borrowing costs, for securitized transactions, amongst banks and other agents in the sector.

The interest rate on a repo transaction is normally higher than that on a reverse repo transaction, with everything else held constant.