Using SDF to Absorb Liquidity

Using SDF to Absorb Liquidity

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The RBI implemented the standing deposit facility, a collateral-free liquidity absorption mechanism, with the intention of transferring liquidity from the commercial banking sector to the RBI. It makes it possible for the RBI to take liquidity—deposits—from commercial banks without having to pay them back with government securities. The Reserve Bank needed the SDF to be able to handle unusual situations in which it needed to absorb large amounts of liquidity, which is why it is important. The RBI has struggled with liquidity absorption in the past as a result of events like the global financial crisis and demonetization. Through the SDF, banks can overnight deposit funds with the RBI. However, the RBI has the option to absorb liquidity for longer tenors under the SDF with appropriate pricing if necessary. All liquidity adjustment facility (LAF) participants would be eligible to participate in the SDF scheme.

SDF absorbing the liquidity - Because the RBI is no longer obligated to disclose government securities on the balance sheet, SDF allows for greater flexibility in the management of excess liquidity. How? There will be two entries on the balance sheet for each SDF: on the liability side, one under currency-in-circulation and one under net claims on banks. The RBI's ability to absorb more liquidity is enhanced by this negligible impact on its balance sheet. As of now, short-term stores will be dependent upon the SDF rate, which will be 25 premise focuses underneath the approach rate (Repo rate). Nonetheless, it would continue to be able to absorb longer-term liquidity when necessary with the appropriate pricing. The RBI's objective is to reduce the system's liquidity surplus to a level that is in line with the current monetary policy. Returning to our initial query, why did we need to introduce a new instrument when we already had a Reverse Repo facility to absorb liquidity?

What distinguishes SDF from a Reverse Repo facility? - To remove excess liquidity from the system, the central bank uses the Reverse Reporate and SDF. Reverse Repo operations, in contrast to SDF, require the RBI to deposit government assets as collateral in order for commercial banks to lend money to them. Reverse repos, open market operations, and the cash reserve ratio are all options available to the Reserve Bank under the current liquidity system. In contrast, SDF will permit banks to store excess liquidity at their discretion with the Reserve Bank.

The fixed-rate overnight Reverse Repo is no longer the floor of the LAF corridor as a result. The reverse repo, on the other hand, will continue to be a tool in the RBI's arsenal for monetary policy, and its application for periodically announced goals will be at the RBI's discretion. The RBI created this instrument to absorb market excess liquidity, which is a major factor in setting policy rates. You must be aware that the change in policy rates will affect the rates you pay on your savings and loans. Therefore, in addition to the other rates, one must pay close attention to the SDF rate.