In its first bi-monthly monetary policy meeting for FY 2023, the Reserve Bank of India announced a new tool to absorb excess liquidity from the system – Standing Deposit Facility (SDF). Through this new tool the central bank can absorb excess liquidity from the commercial banks, which is currently hovering at about Rs 8.5 lakh crore, without an exchange of collateral like government-backed securities (G-Secs). 

Interest rates: SDF vs reverse repo

Interest rate for SDF has been fixed at 3.75 per cent, 40 basis points higher than reverse repo rate. It is a win-win for both the central bank and commercial banks, as it will be more attractive for the commercial banks to pump that liquidity back to the central bank due to higher returns, while for the central bank it would not need to offer any security to the commercial bank. 

“The SDF rate will be 25 bps below the policy rate, and it will be applicable to overnight deposits at this stage. It would, however, retain the flexibility to absorb liquidity of longer tenors as and when the need arises, with appropriate pricing,” the RBI Governor Shaktikanta Das said in the policy statement Friday.

How can the banks avail this facility?

The SDF is currently available as an overnight facility where banks can engage in transactions through the overnight SDF facility which will be available to them between 17:30 hrs to 23:59 hrs on all days, including Sundays and holidays. It would be reversed on the following working day in Mumbai. Banks can use the central bank’s electronic portal, ie, the e-Kuber system to use the facility. The scheme is effective as of April 8, 2022, the RBI said.

When was SDF first introduced?

The idea about SDF was initially introduced nearly eight years ago by a monetary policy committee led by Urijit Patel, who was then the deputy governor of the central bank. The Urijit Patel committee came up with the idea of a collateral free facility after the experiences of the 2005-2008 period, when there was a surge in liquidity, which left the central banks short of collateral. The committee suggested SDF as a non-collateralized concurrent offering. In 2018, the Reserve Bank of India Act was empowered to introduce the new tool after the government allowed it to amend the RBI Act in the Finance Bill of 2018. The amendment came as a result of demonetisation when banks were plush with excess cash.

How will SDF help RBI in managing liquidity going ahead?

ICICI Direct said RBI’s introduction of DDF effectively marks the rate hike of lower end of the LAF (liquidity adjustment facility) corridor at 3.75% . “While RBI has not raised the reverse repo rate, it has introduced a standing deposit facility (SDF) at 3.75% (25 bps lower than repo rate) as the floor of the LAF corridor. Indirectly, the reverse repo rate hike is at 40 bps as overnight rates will now be pegged at 3.75% apart from VRRR (variable reverse repo rate) that is variable in nature and currently hovers around repo rate levels,” the brokerage said.

SBI Research said since the SDF comes with the conditionality of no collateral of G-secs to be given by the RBI to banks, it will free up securities from SLR holdings of banks. This will thus result in lowering of excess SLR holdings and will lead to an increase in demand for bonds. Barclays India said it expects policy rate hikes of 50 basis points that will push the repo rate to 4.5 per cent, with the new SDF floor rising to 4.25 per cent by end-2022.