Liquidity Adjustment Corridor:

Liquidity Adjustment Corridor:

Subject: Economy

Section: Monetary Policy

Context:

The Reserve Bank of India (RBI) has introduced a non-collateralized Standing Deposit Facility (SDF) to absorb surplus liquidity from the banking system at a higher interest rate.

RBI will now use SDF at 3.75% as the floor rate for Liquidity Adjustment Facility (LAF) corridor instead of Fixed Reverse Repo Rate at 3.35%

What?

SDF is a Reverse Repo Facility at a higher rate and without collaterals from RBI.

Under SDF banks will be able to park their surplus money (lend to the RBI) but at a higher rate than reverse repo rate.

Why?

SDF rate of 3.75 per cent will be the new floor rate for the Liquidity Adjustment Facility (LAF) corridor, replacing the fixed rate reverse repo.

So far, RBI used three policy rates under the LAF corridor to manage its monetary policy operations:

• repo rate- at which it lends to banks,
• reverse repo rate- at which it drains excess liquidity from banks,
• marginal standing facility-rate at which RBI supplies liquidity on overnight basis (above the repo rate). It acted as the ceiling rate under the LAF corridor.

Introduction of the SDF thus acts as the floor rate under the LAF corridor as being above the fixed reverse repo rate.

This has resulted in normalisation of the LAF corridor to pre-pandemic level of 50 basis points, with SDF being 25 basis points below the repo rate and the marginal standing facility (MSF) 25 basis points above the repo rate. And it can be seen as the first concrete step for both policy and liquidity normalisation. significant change in the design of LAF itself.

Changes in details:

The policy repo (4%) and reverse repo rates (3.35%), both of which are collateralised overnight rates, used to be the upper and lower bounds respectively of the LAF corridor till now.

These will be replaced by two standing facility rates — MSF or Marginal Standing Facility (4.25 per cent) and SDF or Standing Deposit Facility (3.75 per cent) as being lower than Repo Rate and above Reverse Repo Rate respectively.

Advantages:

• Remove constraints on liquidity absorption mechanism– Since RBI can get money without parting Gsec as the collateral to the lenders as done under reverse repo facility.
• Benefits to Banks through arbitrage– the market repo rate was around 3.40 per cent and, with SDF at 3.75, banks with excess SLR (Statutory Liquidity Ratio) can borrow through market repo/TREPS at lower rates, and the amounts so borrowed can be parked with the RBI at higher SDF which would not attract capital charge, for engaging in arbitrage in preference to making loans which attract capital charge.