Standing deposit facility in the offing

Report of the Reserve Bank of India's internal group on liquidity adjustment facility

The Reserve Bank of India (RBI), in its bid to fine tune the liquidity adjustment facility (LAF), has proposed instituting a standing deposit facility over and above the required cash reserve ratio deposits.

As per the recommendations of the internal report on LAF, the introduction of a deposit facility becomes essential to afford more flexibility to RBI in using the repo facility as a signaling device while not sacrificing the objective of the provision of a floor to the movement of short term interest rates.

However, the group has also acknowledged the fact that the institution of such a facility distinct from CRR for banks will necessitate a suitable amendment to the RBI Act 1934.

Thus, the standing deposit type facility as a tool for residual liquidity management is more efficient as it distinguishes between banks having surplus cash balances from those that are in deficit, said the report.

On the interest rate front, since rates on standing deposit facility is designed to provide a floor to the interest rate corridor, it should be pegged at a rate lower than the repo rate, the report said.

As far as CRR is concerned, the interest rate on CRR may be aligned with the desired interest rate on the proposed standing deposit type facility.

Accordingly, it has been suggested that the interest rate on CRR should be delinked from the bank rate and placed at a rate lower than the repo rate.

In order to cope with future situations of excess liquidity and shortage, it has suggested there could be two rates at which liquidity will be injected and a single rate at which liquidity would be absorbed.

The minimum tenor of the repo and reverse repos under LAF, should be changed from overnight to 7- days to be conducted on a daily basis to enable balanced development of various segments. The minimum bid amount of Rs 5 crore and in multiples will continue for repos and reverse repos.

On the other hand, the bank rate which has lost its significance as a signalling device, will continue to be aligned to reverse repo and, therefore, the entire liquidity support including refinance should be made available at the reverse repo/bank rate.

Thus, the bank rate/reverse repo will therefore continue to provide the upper bound to the interest rate corridor.