What’s in the news?

• The RBI has introduced the Standing Deposit Facility (SDF), an additional tool for absorbing liquidity, at an interest rate of 3.75 per cent.

Role of SDF

• The main purpose of SDF is to reduce the excess liquidity of Rs 8.5 lakh crore in the system, and control inflation.
• In 2018, the amended Section 17 of the RBI Act empowered the Reserve 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.
• Through this new tool the central bank can absorb excess liquidity from the commercial banks, which is currently hovering at about Rs 8.5 lakh crore, without an exchange of collateral like government-backed securities (G-Secs).
• Interest rate for SDF has been fixed at 3.75 per cent, 40 basis points higher than reverse repo rate. It is a win-win for both the central bank and commercial banks, as it will be more attractive for the commercial banks to pump that liquidity back to the central bank due to higher returns, while for the central bank it would not need to offer any security to the commercial bank.
• The SDF will replace the fixed rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor. Both the standing facilities — the MSF (marginal standing facility) and the SDF will be available on all days of the week, throughout the year.

How it will operate

• The SDF rate will be 25 bps below the policy rate (Repo rate), and it will be applicable to overnight deposits at this stage. It would, however, retain the flexibility to absorb liquidity of longer tenors as and when the need arises, with appropriate pricing.
• The RBI’s plan is to restore the size of the liquidity surplus in the system to a level consistent with the prevailing stance of monetary policy.

Reverse repo rate

• The fixed rate reverse repo (FRRR) rate which is retained at 3.35 per cent will remain 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.

Question of liquidity

• 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.
• This has pushed up the retail inflation level in the system.

Reference:

1. https://indianexpress.com/article/explained/everyday-explainers/what-is-standing-deposit-facility-7859803/