RBI is planning to introduce a new monetary-policy tool in the coming financial year to better manage a banking system swimming in excess cash.
The so-called Standing Deposit Facility, or SDF, will help the Reserve Bank of India absorb surplus funds without having to provide lenders collateral in exchange.
This concept was first recommended by the Urjit Patel committee report in 2014.
Standing deposit facility is a remunerated facility that will not require the provision of collateral for liquidity absorption. Banks, at different points in time, may be short of funds or flush with money. When they need money for the short-term, they borrow from the bankers’ bank—RBI. Repo rate — that RBI sets at every monetary policy — is the rate at which banks borrow funds, for which they pledge government securities. What happens when banks have excess funds? They lend it to the RBI at the reverse repo rate that is lower than the repo rate. Here too, government securities act as collateral.
Standing Deposit Facility will allow the RBI to absorb surplus funds from banks without collateral. Banks too continue to earn interest (though possibly lower than the existing reverse repo rate). In effect, it will empower the RBI to suck out as much liquidity as needed.
Background:
Indian banks were flooded with cash after Prime Minister Narendra Modi invalidated 86 percent of the nation’s currency in circulation in Dec 2016 and mandated the worthless notes be deposited with lenders.
Banks scrambled to park these funds with the RBI, forcing the central bank to raise the limit on a scheme it uses to mop up excess liquidity. The surplus, however, has persisted, restricting the RBI’s ability to intervene in currency markets at a time when the rupee is appreciating.
The SDF will largely replace the Market Stabilization Scheme, which uses bonds issued outside the government’s regular borrowings to mop up liquidity.