The Reserve Bank of India (RBI) has announced that overnight balances held by banks with the RBI under the Standing Deposit Facility (SDF) will be eligible as “Level 1 High Quality Liquid Assets (HQLA)” for the computation of the Liquidity Coverage Ratio (LCR).
- The announcement came after the RBI received concerns from banks asking for clarification on the treatment of SDF under the Liquidity Risk Management Framework.
i.This circular is effective immediately and applicable to all Commercial Banks (excluding Local Area Banks, Regional Rural Banks and Payments Banks).
ii.This will improve banks’ ability to achieve a high Liquidity Coverage Ratio (LCR).
High Quality Liquid Assets (HQLA)
i.HQLAs include cash, including cash reserves in excess of the required Cash Reserve Ratio (CRR); Government Securities (G-Sec) in excess of the Minimum Statutory Liquidity Ratio (SLR) requirement; G-Sec within the mandatory SLR requirement, to the extent approved by the RBI under MSF; and marketable securities issued or guaranteed by foreign sovereigns meeting specific conditions, among others.
ii.As the stock of unencumbered HQLA is meant to serve as a defence against the potential onset of liquidity stress, banks are required to maintain a minimum LCR of 100% (that is, the stock of HQLA should at least equal total net cash outflows) on an ongoing basis.
Liquidity Coverage Ratio (LCR)
The Basel Committee on Banking Supervision (BCBS) developed the LCR to increase the short-term resilience of the liquidity risk profile of banks.
- The LCR is intended to ensure that banks have enough HQLA to survive a significant liquidity crisis scenario lasting 30 calendar days.
Standing Deposit Facility (SDF)
i.The Standing Deposit Facility (SDF) is a collateral-free liquidity absorption tool that intends to move funds from the commercial banking system into the RBI.
- It was institutionalized in April 2022 and took the role of the Fixed Rate Reverse Repo (FRRR) as the floor of the Liquidity Adjustment Facility (LAF) corridor.
- Following the introduction of SDF, the FRRR operations will be at the discretion of the RBI for purposes defined from time to time.
ii.SDF allows the RBI to absorb excess cash from the economy by sucking liquidity from commercial banks without giving government securities in return to the lenders.
- As a means of absorbing liquidity, SDF is available without the need for collateral, in contrast to FRRR, which is used for overnight liquidity
Note: Currently, the SDF rate is 5.65%, 25 basis points less than the repo rate (5.90%).
Reverse Repo Rate
i.Reverse Repo Rate is the interest rate paid by the RBI to commercial banks when they park excess cash with the RBI.
- RBI uses this tool to absorb liquidity from commercial banks in exchange for qualified LAF-eligible government securities as collateral.
ii.When the economy experiences inflation, the RBI raises the reverse repo rate to absorb excess funds from the market, reducing the amount of money available for the public to borrow.
Note: RBI uses both SDF and the reverse repo rate to absorb liquidity in the system.
Liquidity Adjustment Facility (LAF)
The LAF refers to the actions carried out by the RBI to inject/absorb liquidity from the banking sector.
- It consists of overnight as well as term repo/reverse repo (fixed and variable rates), SDF, and MSF.
i.Repo Rate is the interest rate at which the RBI lends money to commercial banks in order to inject liquidity into the economy.
- Repo stands for “Repurchase Option” or “Repurchase Agreement.”
ii.Under this, the RBI provides liquidity through the LAF to all LAF participants against collateral of government and other approved securities.
- The Repo Rate reflects the middle of the corridor, whereas the Marginal Standing Facility (MSF) indicates the higher end.
Note: Since the RBI is also a bank and must earn more than it lends, the repo rate is higher than the reverse repo rate.
Marginal Standing Facility (MSF)
MSF is an RBI system that allows scheduled commercial banks to access cash overnight.
- MSF rate is around 100 basis points, or 1%, higher than the repo rate and is sanctioned against government securities.
Recent Related News:
In October 2022, the Monetary Policy Committee (MPC) of the RBI raised the repo rate for the 4th consecutive time by 50 basis points to 5.90% from 5.40%. Consequently, the Standing Deposit Facility (SDF) Rate adjusted to 5.65% from 5.15%; and Marginal Standing Facility (MSF) rate and Bank Rate to 6.15% from 5.65%.
About the Reserve Bank of India (RBI):
Governor– Shaktikanta Das
Deputy Governors– Mahesh Kumar Jain, Michael Debabrata Patra, M. Rajeshwar Rao, T. Rabi Sankar
Headquarters– Mumbai, Maharashtra