Reverse repo is the exact opposite of repo.
In a reverse repo transaction, banks purchase government securities form RBI ie Reverse repo rate is the rate at which the central bank of a country (RBI in case of India) borrows money from commercial banks within the country (or banks lend money to the RBI) for a short duration is termed the reverse repo rate.
It is a monetary policy instrument which can be used to control the money supply in the country.
An increase in the reverse repo rate will decrease the money supply
If the reverse repo rate is increased,
discourages the commercial banks to get money as the rate increases and becomes expensive.
it means the RBI will borrow money from the bank and offer them a lucrative rate of interest.
As a result, banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it
Therefore the commercial banks transfer their funds with the RBI
Banks are always happy to lend money to RBI since their money is in safe hands with an attractive rate of interest.
It causes the money to be drawn out of the banking system, thereby decreasing the supply of money in the market.
The RBI uses this tool when it feels there is too much floating in the banking system
Consequently, banks would have lesser funds to lend to their customers.
This helps stem the flow of excess money into the economy
The increase in the Repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit.
As the rates are high the availability of credit and demand decreases resulting to decrease in inflation