Standing Deposit Facility (SDF), RBI’s new tool to absorb excess liquidity to control inflation

While retaining the reverse repo rate at 3.35 per cent, the Reserve Bank of India (RBI) recently introduced the Standing Deposit Facility (SDF).

Standing Deposit Facility (SDF):

• This concept was first recommended by the Urjit Patel committee report in 2014.
• 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 bankers’ bank—RBI.
  • Repo rate — that RBI sets at every monetary policy — is the rate at which banks borrow funds, for which they pledge government securities.
  • What happens 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.
• Standing Deposit Facility 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.
• The SDF rate will be 25 bps below the policy rate (Repo 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’s plan is to restore the size of the liquidity surplus in the system to a level consistent with the prevailing stance of monetary policy.

Role of SDF

• The main purpose of SDF is to reduce the excess liquidity of Rs 8.5 lakh crore in the system, and control inflation.
• In 2018, the amended Section 17 of the RBI Act empowered the Reserve Bank to introduce the SDF – an additional tool for absorbing liquidity without any collateral.
• By removing the binding collateral constraint on the RBI, the SDF strengthens the operating framework of monetary policy.
• The SDF is also a financial stability tool in addition to its role in liquidity management.
• 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.

Question of liquidity

• The “extraordinary” liquidity measures undertaken in the wake of the pandemic, combined with the liquidity injected through various other operations of the RBI, have left a liquidity overhang of the order of Rs 8.5 lakh crore in the system.
• This has pushed up the retail inflation level in the system.
• The RBI will engage in a gradual and calibrated withdrawal of this liquidity over a multi-year time frame in a non-disruptive manner beginning this year.