Standing Deposit Facility is a new liquidity tool introduced by RBI. Please read this article to learn about SDF and how it differs from the reverse repo rate.
The Standing Deposit Facility, proposed to be introduced by the RBI, is a collateral-free liquidity absorption mechanism that aims to absorb liquidity from the commercial banking system into the RBI. Government in the Budget’s (2018) Finance Act included a provision for introducing the Standing Deposit Facility (SDF).
What is Standing Deposit Facility (SDF)?
Standing Deposit Facility allows the RBI to absorb liquidity (deposit) from commercial banks without giving government securities in return to the banks. In the present situation, the main arrangement for the RBI to absorb excess money with the banking system is the famous reverse repo mechanism. Under reverse repo (part of the Liquidity Adjustment Facility), banks will get government securities in return when they give excess cash to the RBI. An interest rate reverse repo rate is also provided to banks.
The inconvenience with this arrangement is that the RBI has to provide securities whenever banks provide funds.
As per the stand of the RBI, when the central bank has to absorb a tremendous amount of money from the banking system through the reverse repo window, it will become difficult for the RBI to provide the such volume of government securities in return. This situation occurred during the time of demonetization.
In this sense, the Standing Deposit Facility (SDF) is a collateral-free arrangement meaning that RBI need not give collateral for liquidity absorption. The SDF will allow the RBI to suck out liquidity without offering government securities as collateral.
Features of SDF
Following are the salient features of SDF.
- A monetary policy instrument to absorb liquidity without collateral
- It has become the floor of the LAF corridor (explained below), replacing the fixed rate reverse repo tool, which means the government won’t accept money for anything lower than the SDF rate.
- The introduction of this tool has increased the reverse repo rate, which leads to a rise in the cost of money.
- Operated on an overnight basis (after market hours)
- Enough flexibility to absorb liquidity for a longer tenor at a pre-determined rate
- Deposits under the SDF will not be considered balances eligible for maintaining the Cash Reserve Ratio (CRR). Still, they will be eligible to maintain the Statutory Liquidity Ratio (SLR).
How does SDF impact liquidity?
Before understanding how it will absorb the liquidity, let’s know what has led to increased liquidity. Below-mentioned is a few of the probable reasons that have led to an increase in liquidity.
- Increase in advance tax receipts
- Increase in public provident funds and small savings receipts
- Temporary postponement of capital expenditure
- Increase in foreign portfolio investment in equity and debt
- Net capital inflows in the form of NRI deposits and trade credit
SDF gives flexibility for surplus liquidity management as it removes the binding constraint on RBI to show government securities on the balance sheet. How? For every SDF, there will be two entries on the balance sheet – on the liability side (currency-in-circulation) and the assets side under net claims on banks. This null impact on the RBI balance sheet gives more opportunity to RBI to absorb surplus liquidity.
Difference between Standing Deposit Facility, Reverse Repo and MSF
Within the existing liquidity management framework, liquidity absorption through reverse repos, open market operations, and the cash reserve ratio (CRR) are at the discretion of the Reserve Bank. On the other hand, using standing facilities (MSF, SDF) would be at the banks’ discretion.
The difference between the Standing Deposit Facility and Reverse Repo is that there is no need for collateral under the SDF.
According to the Finance Act that made the launch of SDF, a separate clause shall be inserted in the RBI Act: “The accepting of money as deposits, repayable with interest, from banks or any other person under the Standing Deposit Facility Scheme, as approved by the Central Board, from time to time, for liquidity management….”
The Urjit Patel Committee first suggested the proposal in its recommendation of the Monetary Policy Framework in 2014.
Conclusion
SDF is a monetary tool that allows banks to park their access liquidity with RBI without any collateral. RBI has introduced this tool to absorb excess liquidity in the market as it plays an important role in determining the policy rates. You must know that this change in policy rates impacts the rates on your deposits and loans. Thus, you must keep an eye on the SDF rate, repo rate, and others.
Notes:
Liquidity Adjustment Facility (LAF) – A tool used in monetary policy that enables banks to either borrow money through repurchase agreements (repo) or lend money to RBI using the reverse repo tool.
LAF Corridor – LAF corridor indicates the difference between the repo rate and the reverse repo rate.
Cash Reserve Ratio (CRR) – The amount that banks have to statutorily maintain in liquid cash with RBI is known as CRR.
Statutory Liquidity Ratio (SLR) – Minimum percentage of deposits that a commercial bank is required to maintain in the form of liquid cash, gold, or government securities.
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