Standing Deposit Facility of RBI

Why in news?

• While retaining the reverse repo rate at 3.35 per cent, the Reserve Bank of India (RBI) on Friday (April 8) introduced the Standing Deposit Facility (SDF), an additional tool for absorbing liquidity, at an interest rate of 3.75 per cent.

About Standing Deposit Facility of RBI:

• The Standing Deposit Facility is a collateral free liquidity absorption mechanism that aims to absorb liquidity from the commercial banking system into the RBI.
  • Thus SDF allows the RBI to absorb liquidity (deposit) from commercial banks without giving government securities in return to the banks.
• The main purpose of SDF is to reduce the excess liquidity in the system, and control inflation.
• In 2018, the amended Section 17 of the RBI Act empowered the Reserve Bank to introduce the SDF.
• The SDF will replace the fixed rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor.
• However 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.
• 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.

Need for SDF:

• In the present situation, the main arrangement for the RBI to absorb excess money with the banking system is the reverse repo mechanism.
  • Under reverse repo (which is a part of the Liquidity Adjustment Facility), banks will get government securities in return when they give excess cash to the RBI. An interest rate of reverse repo rate is also provided to banks.
• The inconvenience with this arrangement is that the RBI has to provide securities every time when banks provide funds.
• As per the stand of the RBI, when the central bank has to absorb tremendous amount of money from the banking system through the reverse repo window, it will become difficult for the RBI to provide such volume of government securities in return. This situation was occurred during the time of demonetisation.
• In this sense, the Standing Deposit Facility (SDF) is a collateral free arrangement meaning that RBI need not give collateral for liquidity absorption.

Add ons:

• Under the existing liquidity framework, liquidity absorption through reverse repos, open market operations and the cash reserve ratio (CRR) are at the discretion of the Reserve Bank.
• But SDF will enable banks to park excess liquidity with the Reserve Bank at their discretion.

PRACTICE QUESTION:

Consider the following statements regarding ‘Standing Deposit Facility of RBI’:

1. The SDF rate will always be above the repo rate.

2. It will enable banks to park excess liquidity with the Reserve Bank at their discretion

Which of the statements given above is/are correct?

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Answer