Rate Corridor

Repo rate is the rate of interest charged by the central bank when banks borrow money from it. It is the tool through which the central bank in-fuses funds into the system by lending to banks against pledging of securities.

The reverse repo is the rate the central bank offers to banks when they deposit funds with it. The central bank drains out liquidity from the financial system through reverse repo by releasing bonds to the banks. This is a daily operation by the central bank to manage liquidity over a longer time.

Interest rate corridor refers to the window between the repo rate and the reverse repo rate wherein the reverse repo rate acts as a floor and the repo as the ceiling. Ideally, rates in the overnight interbank call money market, where lending and borrowing is unsecured, should move within this corridor. However, when banks are short of funds and the overnight call money rates are high and above the repo rate, banks approach the central bank to borrow under the repo window.

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