Difference between Repo Rate and MSF

What is Repo Rate?

It is the rate at which the Reserve Bank of India advances money to commercial banks to meet their short-term liquidity demands. Some banks exchange their securities to RBI for borrowing money, which is followed by a Repurchase Agreement. The Repurchase Agreement asserts that the bank will be repurchasing the securities from RBI in a particular date on a price decided in advance.

What is MSF?

Marginal Standing Facility Rate or MSF is the rate at which the RBI lends its funds overnight to the scheduled banks against government securities. RBI has prefaced this borrowing scheme to control the short-term asset-liability mismatch.

Key Differences between Repo Rate and MSF

Repo rate and MSF are the rates at which RBI lends the money to various other banks. However, there are some fundamental differences between the two rates which are listed below:

• Repo rate applies to loans that are given to banks to meet the short-term financial needs, but MSF is meant for lending overnight to the banks.
• Repo rate is the rate with which the RBI lends money to commercial banks while MSF is the rate at which the RBI lends money to scheduled banks.
• Lending at repo rate involves the selling of bank's securities as collateral to the RBI accompanying a repurchase agreement. Loans provided at MSF rates include giving the government securities as collateral.
• Another significant difference between MSF and repo rate are that the scheduled banks which take loans at the MSF rates are authorized to use the securities that come under SLR (Statutory Liquidity Ratio) in the process of getting loans from the RBI. And consequently, MSF is always 1% more than the repo rate.

Effect of Repo Rate

Higher the repo rate, higher is the significance of the short-term money. When the repo rate is low, banks are expected to pay a lower interest amount on the loans. This affects the loans taken by customers who also end up availing the loans at a lower interest rate.

Effect of MSF Rate

One of the significant features of the MSF is that it is always sustained at 100 bps higher than the repo rate. MSF primarily acts as a prominent liquidity cushion. Higher the MSF rate, more costly is borrowing for the scheduled banks, and the cost trickles down to the corporate borrowers as well as individuals. MSF is employed by RBI to control the money supply in the country.

Recently, the repo rate has been increased by the Reserve Bank of India by 0.25% or 25 basis points on 1st August in the third bi-monthly monetary policy statement of 2018 as a strategy to control the ever-increasing inflation in the economy. This RBI lending rate was previously raised on 6 June by 25 basis points from 6% to 6.25% in the second bi-monthly policy statement by RBI for the financial year 2018-19. The MSF has also been increased due to the recent hike from 6.50% to 6.75%.