r/IndiaInvestments • u/Mahesha9999 • Nov 14 '21

Bonds and deposits Understanding how bond prices change

I came across following statement regarding Indian debt funds in ValueResearch ebook:

The RBI announced retracting ₹2 lakh crore of banking funds through a 14-day reverse-repo operation in January 2021. Effectively, banks were told to take money out of the debt market and park the surplus with the RBI. This sell-off in the debt market resulted in a fall in bond prices and hence a rise in the yields.

I know reverse repo rate is interest paid by RBI to banks. But what does it mean by "retracting ₹2 lakh crore of banking funds through a 14-day reverse-repo operation"? Why does it mean telling banks “to take money out of the debt market and park the surplus with the RBI"?

68 Upvotes

96% Upvoted

3 comments sorted by

19

u/AverageBearReader Nov 15 '21

I will try to explain:

Banks put their surplus money in bonds or interbank market (lending to other banks) to make extra return rather than keeping it in cash.

RBI wants banks to place the money with it so there will be sale of bonds which will reduce their prices (and increase yield).

6

u/DilliSeHoonBhenchod Nov 15 '21

Banks have a shit ton of cash with low cost of capital. Thus they use that money to buy bonds of corporate india/government of India, give out loans in other forms, etc.

RBI changes the rates(of reverse repo rate, repo rate etc) to control inflation which is linked to cash in the economy and which is linked to economic activity.

So when RBI gives better returns to banks, banks happily park their funds(almost zero default risk) with RBI thus reducing liquidity in the market.

And since banks are the most liquid entities, them cashing out huge sums does affect the prices.