Reverse repo out, SDF in: RBI’s new liquidity absorbing tool

The Reserve Bank of India (RBI) has introduced the Standing Deposit Facility (SDF) — a new tool for absorbing liquidity — at an interest rate of 3.75 per cent. With this, the RBI has almost made the reverse repo irrelevant.

The operative rate has gone up by 40 bps with the institutionalisation of the Standing Deposit Facility for the withdrawal of ultra-comfortable liquidity.

The SDF will replace the fixed rate reverse repo (FRRR) as the floor of the LAF (liquidity adjustment facility) corridor. Both the standing facilities viz., the Marginal Standing Facility (MSF) and the SDF will be available on all days of the week, throughout the year.

The FRRR rate, which is retained at 3.35 per cent, will remain as part of the RBI’s toolkit and its operation will be at the discretion of the RBI for purposes specified from time to time. The FRRR, along with the SDF, will impart flexibility to the RBI’s liquidity management framework, the RBI said.

In 2018, the amended Section 17 of the RBI Act empowered the central bank to introduce the SDF — an additional tool for absorbing liquidity without any collateral. By removing the binding collateral constraint on the RBI, the SDF strengthens the operating framework of monetary policy. The SDF is also a financial stability tool in addition to its role in liquidity management. The extraordinary liquidity measures undertaken in the wake of the pandemic, combined with the liquidity injected through various other operations of the RBI, have left a liquidity overhang of the order of Rs 8.5 lakh crore in the system, according to RBI Governor Shaktikanta Das. “The RBI will engage in a gradual and calibrated withdrawal of this liquidity over a multi-year time frame in a non-disruptive manner beginning this year,” Das said while unveiling monetary policy review. The objective is to restore the size of liquidity surplus in the system to a level consistent with prevailing stance of monetary policy, he said.

In 2020, during the pandemic, the width of the LAF corridor was widened to 90 basis points by asymmetric adjustments in the reverse repo rate vis-à-vis the policy repo rate. Aimed at fully restoring the pre-Covid liquidity management framework of February 2020 and in view of gradual return to normalcy in financial markets, the RBI has decided to restore the width of the LAF corridor to its pre-Covid level. With the introduction of the SDF at 3.75 per cent, the policy repo rate being at 4 per cent and the MSF rate at 4.25 per cent, the width of the LAF corridor is restored to its pre-pandemic configuration of 50 bps. Thus, the LAF corridor will be symmetric around the policy repo rate with the MSF rate as the ceiling and the SDF rate as the floor with immediate effect.

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