RBI introduces SDF in a bid to increase effective policy rate
MUMBAI: The Reserve Bank of India (RBI) on Friday effectively raised the policy rate by 40 basis points through the introduction of a standing deposit facility (SDF), through which it seeks to suck out the excess liquidity in the system, but without offering any collateral to banks.
RBI will now use SDF as the floor rate for Liquidity Adjustment Facility (LAF) corridor, instead of the reverse repo, which was kept unchanged at 3.35%. Under the new facility, banks will be able to park their surplus money with the RBI, but at a higher rate of 3.75%.
So far, RBI used three policy rates under the LAF corridor to manage its monetary policy operations, including repo rate, at which it lends to banks, reverse repo rate or the rate at which it drains excess liquidity from banks, and the marginal standing facility (MSF) rate at which RBI supplies liquidity when conditions are challenging. The introduction of this facility will help RBI normalise the width of the LAF corridor to pre-pandemic levels of 50 basis points, with the repo being the target rate.
“It has now been decided to introduce the SDF as the floor of LAF corridor. This would provide symmetry to the operating framework of monetary policy by introducing a standing absorption facility at the bottom of LAF corridor, similar to the standing injection tool at the upper end of the corridor, namely the MSF. Thus, at both ends of LAF corridor, there will be standing facilities,” Shaktikanta Das, governor , RBI, said. RBI dropped its pledge to keep the policy loose “as long as necessary” for the first time since late 2019. “RBI will engage in a gradual and calibrated withdrawal of excess liquidity over a multi-year time frame in a nondisruptive manner, beginning this year. The aim is to restore the size of the liquidity surplus in the system to a level consistent with the prevailing stance of the monetary policy,” it said.
Since last year, RBI has been absorbing excess liquidity via variable rate reverse repo auctions. It allowed banks to bid higher than the reverse repo rate, and pushing the weighted average call money rate close to 3.95%. In February, RBI said VRRR and variable rate repo of 14-day tenor will operate as the primary liquidity management tool. “With 80% surplus liquidity absorbed under VRRR at a rate closer to te repo rate of 4%, the SDF at 3.75% will improve returns on the balance liquidity placed by banks at a reverse repo rate of 3.35%,” said Anil Gupta, vice president and co-group head, ICRA Ltd.
This could also lead to an increase in overnight call money rates and will be positive for profitability of banks. This will however also lead to a further increase in short-term rates such as T-bill and consequent increase in borrowing costs linked to such rates. We also expect banks to raise deposit rates in short-term buckets as they can park the liquidity so generated at better rates,” said Anil Gupta, vice president & co-group head, ICRA holding them till maturity.