Liquidity Adjustment Facility: REPO vs Reverse REPO vs Variable Rate Reverse Repo, Marginal Standing facility vs Standing Deposit Facility

 

Liquidity Adjustment Facility:

Monetary policy tool, primarily used by the RBI, to manage liquidity and provide economic stability by using REPO and Reverse REPO as tool. RBI adopted in 1998 on recommendation of Narasimham committee.

Repo Rate: 

The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).

REPO Rate is inversely proportional to the liquidity with the banks. All other rates except REPO rate are decided by RBI governor.

DYNAMICS OF REPO:

If REPO Rate increases ----------------funds will be costlier to consumers ---------------borrowing by people will be less resulting into-------- less Liquidity in the economy 

If REPO Rate decreases --------------- funds will be cheaper to consumers --------------- borrowing by people will be more resulting into ------more Liquidity in the economy

Repo Rate History :

• Since the inception of the Liquidity Adjustment Facility on June 5, 2000, the REPO rate is currently quite low. 
• Repo rate was around 9 % during June 2000 and reached the peak during Aug. 2000 to 16 % in the wake of  rising oil prices making  oil imports more expensive and import inflation in the country.
• As of Nov 2024, it is in the range of 6.5 %.

Marginal Standing Facility (MSF): 

• Monetary arrangement announced by the RBI in the year 2011-12, MSF is a penal rate at which banks can borrow money from the RBI over and above their  borrowing capacity  from the RBI under the LAF window. 
• MSF is always fixed at a higher rate than the Repo rate. 
• Banks can borrow funds under MSF by pledging government securities within the limits of the statutory liquidity ratio (banks cant pledge SLR securities while borrowing under REPO window).
• MSF has been introduced by RBI with the main aim of reducing volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary transmission in the financial system .
• MSF (marginal standing facility) is available on all days of the week, throughout the year.

Reverse Repo Rate:

The interest rate at which the RBI borrows money from banks for the short term often overnight  is defined as Reverse Repo Rate. It is done against the collateral of eligible government securities under the LAF. It is basically done to absorb the liquidity from the market. It is of two types ie 

• Reverse Repo and 
• Variable Reverse Repo.

If Reverse REPO Rate increases----------- the bank will park money with RBI --------- Liquidity with banks will decrease ---------- loans will be costlier to the customers -----------less liquidity in the economy.

If Reverse REPO Rate decreases------------the bank will withdraw money from RBI--------Liquidity with banks will increase --------------- cheaper loans to the customers --------- more liquidity in the economy.

Variable Rate Reverse Repo (VRRR) Auction:

• If the Economy is flush with liquidity, then RBI Since January 2021, had been absorbing money from the banking system via VRRR auctions. 
• RBI ask banks to keep their deposit money with RBI and RBI will pay interest above reverse repo rate (and below repo rate) BUT the rate will be decided through auction. 
• For example, RBI wants to absorb Rs. 50,000 crore liquidity then RBI will select those banks which quotes (asks for) minimum interest rate above reverse repo rate. This VRRR auction can be for overnight or for longer period. At present, VRRR auctions have tenors of 7, 14 and 28 days.

STANDING DEPOSIT FACILITY :

• The idea of an SDF was first mooted in the Urjit Patel Monetary Policy Committee report in 2014 but it could finally be implemented in April 2022.It is an additional tool of Monetary policy for absorbing liquidity without any RBI collateral. 
• When there is huge liquidity in the system and the central bank has to absorb that huge  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. 
• As the SDF is a collateral-free arrangement, RBI need not to give collateral for liquidity absorption .
• SDF rate is higher than Reverse Repo rate, it provides  banks a greater incentive to use the SDF window to park their excess money.  
• Though SDF is for overnight deposits but it retain the flexibility to absorb liquidity of longer tenors. 

VRRR vs SDF :

• VRRR transactions sought for G-Sec as collaterals while there is no such requirement in case of SDF.
• SDF is active throughout the year while VRRR is discretionary of RBI and it is invoked as and when RBI thinks so because of liquidity in the market.
• The SDF will replace the fixed rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor. Both the standing facilities — the MSF (marginal standing facility) and the SDF will be available on all days of the week, throughout the year.

Corridor: 

• The Corridor in the monetary policy of the RBI refers to the area between MSF  which is the emergency lending rate and SDF which is the liquidity absorption rate. 
• Marginal Standing Facility is the upper ceiling of the Corridor, whereas the Standing Deposit Facility constitutes the lower floor.  
•  The repo rate is usually placed in the middle of the corridor.