RBI considers standing deposit facility to manage extra liquidity

No firm decision has been reached on this, said sources. The SDF, when introduced, will become the lower bound of the corridor for the liquidity management window.

The Reserve Bank of India (RBI) is actively considering introducing Standing Deposit Facility (SDF) for liquidity management, based on which banks can park as much money as they want without getting collateral, and at a lower rate than the reverse repo.

However, no decision has been taken yet, said banking sources. The SDF, when introduced, will become the lower bound of the corridor for the liquidity management window.
 

This is being considered for two reasons. One, the RBI contends that banks are unlikely to lend in a risk-averse environment, no matter what the reverse repo rate, and if the government starts spending, liquidity in the system will rise further.
 

Second, the RBI may not have adequate means to support this huge liquidity operation.

This facility, first proposed by the Urjit Patel Monetary Policy Committee report in 2014, has already received government nod following an amendment to the RBI Act in 2018, vide the Finance Bill.
 

“The RBI Act has anyway been modified to allow for an SDF, as envisaged under the Urjit Patel Committee report. This may now be formally activated, allowing the RBI to accept excess liquidity over the cash reserve ratio (CRR), outside the reverse repo window, without the need for it to provide bonds to the banking system,” said Ananth Narayan, associate professor at SP Jain Institute of Management and Research.
 

The RBI has bond holding of Rs 9 trillion in its books, whereas banks have been parking more than Rs 7 trillion of their surplus funds on a net basis with the RBI. For example, on Monday, banks parked Rs 7.13 trillion in surplus liquidity with RBI, showed data on Tuesday.
 

RBI always maintains at least Rs 2 trillion of bonds in its books, as a buffer. Half of it is there to remain solvent as the banker to the government, and the other used as a buffer for its own hygiene. This buffer is being threatened by the deluge of surplus funds getting parked with RBI.

The central bank can, however, overcome this by buying bonds from the secondary market through its open market operations (OMO). Indeed, this is one option through which the market hopes that the RBI will help manage, through a borrowing programme, at a time when foreign investors are leaving the shores.
 

However, that would also mean financing the government deficit, which both the government and RBI are not willing to do in the first half.

There are, however, other options that the RBI may adopt to discourage banks from parking such huge money with it.

One could be to cap the amount banks can park through the reverse repo window. In doing so, banks would risk incurring a negative carry on surplus funds, and will be forced to invest the same in state development loans or corporate bonds (including those issued by top rated public sector entities).

Banks will also be forced to lend more, to avoid the negative carry.
 

Two, the RBI could also increase the CRR. But it had pared it down by 100 bps to 3 per cent, only on March 27.

After demonetisation, the RBI had increased the CRR to 100 per cent for all incremental deposits piling up with banks, when people were returning high-value notes. This time, the scope for that has vanished, following the CRR last month.
 

The RBI is, however, unlikely to tell banks to lend out money because the central bank doesn’t want to interfere in commercial decisions.