Standing Deposit Facility to absorb banks’ excess liquidity

The SDF will help the central bank in absorbing liquidity (deposits) from commercial banks without giving government securities in return to the banks.

In 2018, the amended Section 17 of the RBI Act empowered the Reserve Bank to introduce the Standing Deposit Facility (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.

Accordingly, it has been decided to institute the SDF with an interest rate of 3.75 per cent with immediate effect. The SDF will replace the fixed rate reverse repo (FRRR) as the floor of the LAF corridor. Both the standing facilities, viz, the MSF and the SDF will be available on all days of the week, throughout the year, RBI stated n a release.

Governor Shaktikanta Das said that the SDF will be at 3.75 per cent, 0.25 percentage points below the repo rate, and 0.50 percentage points lower than the marginal standing facility (MSF) which helps banks with funds when required.

The reverse repo rate under the MSF was a collateralised facility while the SDF is a non-collateralised one.

When the central bank has to absorb a tremendous amount of money from the banking system through the reverse repo window, it becomes difficult for it to provide the required volume of government securities in return. This happened during the time of demonetisation.

In this sense, the SDF is a collateral-free arrangement meaning that RBI need not give collateral for liquidity absorption.

The idea of an SDF was first mooted in the Urjit Patel Monetary Policy Committee report in 2014, which later received the government’s nod following an amendment to the RBI Act in 2018, vide the Finance Bill. Since then, the central bank has proposed introducing the SDF for liquidity management so that banks can park as much money with it as they want without getting collateral, and at a lower rate than the reverse repo rate. The RBI again dusted off the idea of introducing the SDF when the pandemic hit in 2020 too but no decision was taken.

At the time, the State Bank of India (SBI) also supported the idea of an SDF. “Absorption of additional surplus liquidity at a lower rate through SDF will pull down the entire interest rate structure. In particular, lower operative overnight rate, short-term rate and lower supply and generation of additional demand will bring down the yield of long-dated government bonds also, thereby pulling down the sovereign yield curve. This will also reduce the interest cost of RBI,” stated Ecowrap, SBI’s research report, dated 8 May 2020.

Economists say it is difficult to state the exact reason behind introducing the SDF now, but some of the contributing factors may include bank mergers and encouraging the borrowing programme.

According to the circular issued on Friday by the RBI, amounts deposited will also count towards the statutory liquidity ratio (SLR).