Context: In its bi-monthly policy review of December 2023, the central bank permitted a reversal of liquidity facilities under SDF and MSF even on weekends and bank holidays, with effect from December 30, 2023.

• The Reserve Bank of India (RBI) has two powerful liquidity adjustment tools: the Standing Deposit Facility (SDF) and the Marginal Standing Facility (MSF). 

Purpose

• The move aims to improve liquidity management amid high utilization by banks.

• Deficit liquidity conditions persisted during October and November prompting large recourse to the marginal standing facility (MSF) by banks.

• In parallel, utilisation of the standing deposit facility (SDF) has also been high. 

• The overall tightening of liquidity conditions is attributed mainly to higher currency leakage during the festive season, government cash balances and Reserve Bank’s market operations,

• It is expected that this measure will facilitate better fund management by the banks. 

Liquidity Management Tools of RBI

• Under the Reserve Bank of India, Act,1934 (RBI Act,1934) (as amended in 2016), RBI is entrusted with the responsibility of conducting monetary policy in India with the primary objective of maintaining price stability while keeping in mind the objective of growth.

• There are several direct and indirect instruments that are used for implementing monetary policy.

• Standing Deposit Facility (SDF) Rate: The rate at which the Reserve Bank accepts non collateralized deposits, on an overnight basis, from all LAF participants.

• It is also a financial stability tool in addition to its role in liquidity management. The SDF rate is placed at 25 basis points below the policy repo rate. 

• Marginal Standing Facility (MSF) Rate: The penal rate at which banks can borrow, on an overnight basis, from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a predefined limit (2 percent).

• This provides a safety valve against unanticipated liquidity shocks to the banking system.

• The MSF rate is placed at 25 basis points above the policy repo rate.

• Repo Rate: The interest rate at which the Reserve Bank provides liquidity under the liquidity adjustment facility (LAF) to all LAF participants against the collateral of government and other approved securities.

• Liquidity Adjustment Facility (LAF): The LAF refers to the Reserve Bank’s operations through which it injects/absorbs liquidity into/from the banking system.

• It consists of overnight as well as term repo/reverse repos (fixed as well as variable rates), SDF and MSF. 

• LAF Corridor: The LAF corridor has the marginal standing facility (MSF) rate as its upper bound (ceiling) and the standing deposit facility (SDF) rate as the lower bound (floor), with the policy repo rate in the middle of the corridor.

• Main Liquidity Management Tool: A 14-day term repo/reverse repo auction operation at a variable rate conducted to coincide with the cash reserve ratio (CRR) maintenance cycle is the main liquidity management tool for managing frictional liquidity requirements.

• Fine Tuning Operations: The main liquidity operation is supported by fine-tuning operations, overnight and/or longer tenor, to tide over any unanticipated liquidity changes during the reserve maintenance period.

• In addition, the Reserve Bank conducts, if needed, longer-term variable rate repo/reverse repo auctions of more than 14 days.

• Reverse Repo Rate: The interest rate at which the Reserve Bank absorbs liquidity from banks against the collateral of eligible government securities under the LAF.

• Following the introduction of SDF, the fixed rate reverse repo operations will be at the discretion of the RBI for purposes specified from time to time.

• Bank Rate: The rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers.

• The Bank Rate acts as the penal rate charged on banks for shortfalls in meeting their reserve requirements (cash reserve ratio and statutory liquidity ratio). 

• The Bank Rate is published under Section 49 of the RBI Act, 1934.

• This rate has been aligned with the MSF rate and, changes automatically as and when the MSF rate changes alongside policy repo rate changes.

• Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank as a per cent of its net demand and time liabilities (NDTL) as on the last Friday of the second preceding fortnight that the Reserve Bank may notify from time to time in the Official Gazette.

• Statutory Liquidity Ratio (SLR): Every bank shall maintain in India assets, the value of which shall not be less than such percentage of the total of its demand and time liabilities in India as on the last Friday of the second preceding fortnight, as the Reserve Bank may, by notification in the Official Gazette, specify from time to time and such assets shall be maintained as may be specified in such notification (typically in unencumbered government securities, cash and gold).

• Open Market Operations (OMOs): These include outright purchase/sale of government securities by the Reserve Bank for injection/absorption of durable liquidity in the banking system.