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CMA Foundation · Fundamentals of Business Economics and Management · Money and Banking

Under the RBI's liquidity adjustment facility, what happens when a commercial bank borrows funds from the RBI at the repo rate?

In a repo operation the bank sells government securities to the RBI to raise short-term money and agrees to repurchase them later at a higher price. The difference is the repo rate. Reverse repo is the opposite, where banks park surplus funds with the RBI.

  1. AThe bank sells securities to the RBI with an agreement to repurchase them laterCorrect
  2. BThe bank buys securities from the RBI permanently
  3. CThe bank deposits surplus funds with the RBI against securities
  4. DThe bank pays a penalty for failing to maintain the Statutory Liquidity Ratio

Explanation

Repo means repurchase agreement: the bank sells eligible government securities to the RBI to obtain short-term funds and agrees to buy them back at a set price, the difference reflecting the repo rate. Option C describes reverse repo, where the bank lends to the RBI.

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