RBI’s VRRR auction gets tepid response, again

Repo rate is the rate at which the central bank issues loans to commercial banks in case of shortage of funds. It is used to control inflation. A reverse repo is a fixed or variable interest rate at which banks lend to RBI. VRRR is a subdivision of reverse repo. The VRRR is usually undertaken to reduce surplus liquidity by withdrawing existing cash in the system. Repo rate is the rate at which the central bank issues loans to commercial banks in case of shortage of funds. It is used to control inflation. A reverse repo is a fixed or variable interest rate at which banks lend to RBI. VRRR is a subdivision of reverse repo. The VRRR is usually undertaken to reduce surplus liquidity by withdrawing existing cash in the system.

Concept:

• The central bank uses various ways to increase or decrease liquidity in the banking system. Repo rate is the rate at which the central bank gives loans to commercial banks against government securities. Reverse repo rate is the interest that RBI pays to banks for the funds. VRRR is a sub-type of reverse repo
• Since January 2021, RBI had been absorbing money from the banking system via VRRR auctions. But the frequency was increased to 14 days in August 2021
• In December, the central bank announced that it may use longer-term VRRRs, but the size and maturity details were not announced
• RBI has indicated that it will use VRRR auctions as the main liquidity management operation
• RBI’s rebalancing of liquidity management started in February 2020, as the central bank shifted its liquidity absorption tool out of the fixed-rate overnight reverse repo window into VRRR auctions of longer maturity.
• In order to absorb additional liquidity in the system, the RBI announced conducting a VRRR program because it has higher yield prospects as compared to the fixed rate overnight reverse repo.

How Does It Work?

• VRRR is kept higher than the reverse repo rate but lower than the repo rate to attract funds from banks
• To enjoy the higher rates, banks would attract deposits and to do that, they would offer higher interest rates on deposits. This way, money will go from the depositors to the banks and from the banks to the central bank, thus leading to less liquidity
• The auction route is used so that the banks that are ready to accept the lowest interest rates for deposits with RBI are selected, i.e., at the minimum interest rate above the reverse repo rate. For example, as the reverse repo rate is 3.35 per cent, a bank that is ready to accept, say, 3.5 per cent interest for its funds will win over a bank that wants, say, 3.7 per cent (even though both these are below the 4 per cent repo rate)

Long Term Reverse Repo Operation (LTRO)

• LTRR is one of the instruments to manage durable liquidity under the RBI’s revised liquidity management framework. It has a tenor of over 14 days Banks’ prefer investing in treasury bills of 91 days, 182 days and 364 days duration as the bills can be easily liquidated to fund future demand for loans. However, if they invest in LTRR, this flexibility will not be available.
• Long Term Reverse Repo Operation (LTRO) is a mechanism to facilitate the transmission of monetary policy actions and the flow of credit to the economy. This helps in injecting liquidity in the banking system.
• Funds at LTRO are provided at the repo rate. The banks can avail one year and three-year loans at the same interest rate of one day repo. The loans with higher maturity period (here like 1 year and 3 years) will have a higher interest rate compared to short term (repo) loans.
• LTROs are conducted on Core Banking Solution (E-KUBER) platform. The operations would be conducted at a fixed rate.
• The minimum bid amount would be Rs 1 crore and multiples thereof. There will be no restriction on the maximum amount of bidding by individual bidders.
• The Variable Repo Rate (VRR) auction is usually undertaken to withdraw excess liquidity from the system. It is done to tackle inflation. A reverse repo is a fixed or variable interest rate at which banks lend to RBI.

Operational Guidelines For VRR Auction

• The auction is conducted on CBS (e-Kuber) platform.
• The minimum bid amount for the auction would be Rupees one crore and multiples thereof. The allotment would be in multiples of Rupees one crore.
• Banks would be required to place their bids in percentage terms up to two decimal places. Banks can place multiple bids.
• Successful bids will get accepted at their respective bid rates.
• Bids at or below the repo rate will be rejected.
• Once the bidding time is over, all the bids would be arranged in descending order of the rates quoted and the cut-off rate would arrive at the rate corresponding to the notified amount of the auction. Successful bidders would be those who have placed their bids at or above the cut-off rate. All bids lower than the cut-off rate would be rejected.
• There will be the provision of pro-rata allotment should there be more than one successful bid at the cut-off rate.
• RBI will, however, reserve the right to (i) inject a marginally higher amount than the notified amount due to rounding effects and (ii) inject less than the notified amount without assigning any reasons therefor.
• The reversal of the above auction would take place at the ‘start of day’ on the date of reversal.
• The eligible collateral and the applicable haircuts will remain the same as for LAF.