Standing Deposit Facility

Why in news?

The Standing Deposit Facility, proposed by the RBI and under examination by the Centre, is viewed as a strong tool to suck out the surplus liquidity.

What is it?

• This concept, first recommended by the Urjit Patel committee report in 2014, may soon become part of the central bank’s toolkit to manage liquidity.
• Standing deposit facility is a remunerated facility that will not require the provision of collateral for liquidity absorption.
• Banks, at different points in time, may be short of funds or flush with money.
• When they need money for the short-term, they borrow from the RBI (Repo Rate) for which they pledge government securities.
• When banks have excess funds they lend it to the RBI at the reverse repo rate that is lower than the repo rate. Here too, government securities act as collateral.

Why the facility is introduced now?

• The demonetisation exercise has left banks flush with funds.
• The past two months, banks have been lending left, right and centre to the RBI under the reverse repo window.
• And with the RBI increasing the reverse repo rate by 25 basis points to 6 per cent in the April policy, banks now earn more on these funds.
• The worry is there may be only so much (limited) collateral to go around.
• Collateral may become a constraining factor if the central bank runs out of securities to absorb liquidity under the reverse repo window.
• Enter the Standing Deposit Facility. This will allow the RBI to absorb surplus funds from banks without collateral.
• Banks too continue to earn interest (though possibly lower than the existing reverse repo rate). In effect, it will empower the RBI to suck out as much liquidity as needed.

Why is it important?

• Liquidity plays a key role in transmission of policy rates.
• In a falling rate cycle, pass-through of rate cuts will happen quickly if there is sufficient liquidity, as banks will be able to lower deposit rates comfortably.
• The reverse holds true now. Excess liquidity has led to short-term market rates slipping below the RBI’s policy repo rate.
• Now, RBI would want to keep a tight leash on rates. The RBI would want its key policy rate i.e., the repo rate, to be the operational rate.
• The RBI’s management of rates impacts the rates on your deposits and loans.
• The immediate fallout of excess liquidity in the past few months has been the sharp cuts in bank deposit rates.
• If the RBI curbs excess liquidity and halts the fall in short-term rates, then the depositors can breathe a sigh of relief.

Source:  Business Line