RBI to absorb excess liquidity

The Reserve Bank of India (RBI) in its first policy review of the fiscal year 2023 decided to introduce a new tool - standing deposit facility (SDF) in April 2022 to absorb excess liquidity from the commercial banks which is hovering near Rs 8.5 lakh crore without an exchange of collateral like government-backed securities (G-Secs). This tool will help in gradual withdrawal of the liquidity measures unveiled during the pandemic in a non-disruptive manner and restore the size of the liquidity surplus consistent with prevailing monetary policy stance.

The idea of SDF was first coined by Urjit Patel Monetary Policy Committee in 2014 and the required legislative amendment to implement SDF was made in 2018.  Before we discuss more about SDF let us simplify some of the technical terms.

The RBI Governor Shaktikanta Das stated that currently the liquidity management is characterized by two-way operations: through variable rate reverse repo (VRRR) auctions of varying maturities to absorb liquidity; and variable rate repo (VRR) auctions to meet transient liquidity shortages and offset mismatches. This approach will be continued. 

Introduction of SDF will provide symmetry to the operating framework of monetary policy by introducing a standing absorption facility at the bottom of the LAF corridor, similar to the standing injection tool at the upper end of the corridor, namely the MSF. The SDF will replace the fixed rate reverse repo (FRRR) as the floor of the LAF corridor. Thus, at both ends of the LAF corridor, there will be standing facilities – one to absorb and the other to inject liquidity. Accordingly, access to SDF and MSF will be at the discretion of banks, unlike repo/reverse repo, open market operations (OMO) and cash reserve ratio (CRR) which are available at the discretion of the Reserve Bank.

The SDF along with the FRRR will impart flexibility to the RBI’s liquidity management framework and also act as a financial stability tool which will aid RBI to suck out excess liquidity without offering any securities but also moves overnight rates higher without actually hiking rates. SDF set higher than the FRRR can help to incentivized banks and without any operational issues of offering securities also made easier for the RBI to pull out excess liquidity which is too large to normalize in few months. In April 2022 policy RBI had set SDF at 3.75% which is higher than FRRR of 3.35%.  Since RBI increased the repo rate by 40 basis points to 4.40% on May 4, 2022; the SDF and MDF will now be at 4.15% and 4.65%, respectively. The CRR will be increased by 50 basis points to 4.5% with effect from May 21, 2022 which will suck out Rs 87,000 crore from the banking system.

The SDF is currently available as an overnight facility where banks can engage in transactions through the overnight SDF facility which will be available on all days of the week, throughout the year.  

Summing up

The RBI’s monetary policy stance has always been in tandem with the underlying economic scenario. With rising inflationary risk and gradual revival of the economic activity, RBI’s policy stance continues to be accommodative while focusing on the withdrawal of accommodation which is there for two years to deal with the pandemic blow.