Role of SDF
- The Reserve Bank has taken steps towards normalisation of liquidity management to pre-pandemic levels, with the introduction of the standing deposit facility (SDF) as the basic tool to absorb excess liquidity, and narrowing the liquidity adjustment facility (LAF) to 0.50% from the 0.90%.
- Governor Shaktikanta Das said the SDF would be at 3.75%, ie, 0.25% below the repo rate and 0.5% lower than the marginal standing facility (MSF) which helps the banks with funds when required.
- The SDF has its origins in a 2018 amendment to the RBI Act and is an additional tool for absorbing liquidity without any collateral.
- By removing the binding collateral constraint on the RBI, the SDF strengthens the operating framework of monetary policy. It is also a financial stability tool.
How it will operate
- The main purpose of SDF is to reduce the excess liquidity of Rs 8.5 lakh crore in the system, and control inflation.
- In 2018, the amended Section 17 of the RBI Act empowered the Reserve Bank to introduce the SDF – an additional tool for absorbing liquidity without any collateral. By removing the binding collateral constraint on the RBI, the SDF strengthens the operating framework of monetary policy. The SDF is also a financial stability tool in addition to its role in liquidity management.
- Through this new tool the central bank can absorb excess liquidity from the commercial banks, which is currently hovering at about Rs 8.5 lakh crore, without an exchange of collateral like government-backed securities (G-Secs).
- Interest rate for SDF has been fixed at 75 per cent, 40 basis points higher than reverse repo rate. It is a win-win for both the central bank and commercial banks, as it will be more attractive for the commercial banks to pump that liquidity back to the central bank due to higher returns, while for the central bank it would not need to offer any security to the commercial bank.
- The SDF will replace the fixed rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor. Both the standing facilities — the MSF (marginal standing facility) and the SDF will be available on all days of the week, throughout the year.
Repo Rate & Reverse Repo Rate
- 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.
- The RBI’s plan is to restore the size of the liquidity surplus in the system to a level consistent with the prevailing stance of monetary policy.
- Repo rate is the rate of interest which is applied by RBI to commercial banks when the latter borrows from RBI. Reverse Repo rate is the rate at which RBI borrows money from commercial banks by lending securities.
- Both the Repo rate and Reverse Repo rate are used to control inflation and money supply in the economy.
- In the event of rising inflation, the RBI increases the repo rate which will act as a disincentive for banks to borrow from the central bank.
This ultimately reduces the money supply in the economy and thus helps in arresting inflation. Similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.