Standing Deposit Facility (SDF): New Liquidity Tool by RBI

Over time, the Reserve Bank of India (RBI) has introduced and used several tools to absorb liquidity from banks to create a balance between inflation and growth. One of the most popular tools was the reverse repo. Lower reverse repo rates, or interest that the RBI pays banks in return for deposits, were an effective method to attract banks to deposit funds with the central bank. However, in April 2022, the RBI introduced the new Standing Deposit Facility (SDF) to absorb liquidity from commercial banks. In this blog, we will learn more about the SDF- an absorption mechanism that does not involve any collateral, its features, and how it impacts liquidity. Also read: What is a Bank Overdraft Facility?

Introduced by the RBI, the Standing Deposit Facility is a tool that absorbs liquidity from commercial banks without collateral. The government does not need to give securities to banks for deposits. The main purpose of this tool is to absorb excess liquidity from the banking system. The reverse repo (a part of the Liquidity Adjustment Facility) involved banks receiving government securities for the excess cash given to the RBI.The SDF is an important tool as it enables the RBI to deal with unusual circumstances involving large quantities of liquidity and helps avoid issues that arise during events such as demonetization or the global financial crisis. The SDF is an overnight facility, meaning banks can deposit funds with the RBI for a single day. However, the RBI has the option, if required, to absorb liquidity for a longer duration with the correct pricing. Also read: All About the Personal Loan Overdraft Facility

The RBI has designed the Standing Deposit Facility to handle unexpected situations involving the need to absorb extremely large amounts of liquidity. Tools such as reverse repos and Cash Reserve Ratio are at the RBI’s discretion. However, SDF allows banks to make deposits with the RBI at their discretion.The Standing Deposit Facility has the following features:• The Standing Deposit Facility will replace the Fixed Rate Reverse Repo as the LAF corridor’s floor.• The rate of SDF will be 25 basis points less than the policy repo rate.• SDF is an overnight liquidity absorption mechanism with the flexibility for the RBI to increase its duration.• Any entity that is eligible for LAF can use this facility.• The SDF will be available every day, including holidays and weekends.• SDF operations will be carried out on the e-Kuber system of the RBI and function through the electronic mode. Also read: What is Reverse Repo Rate? - A Guide

To understand how SDF impacts liquidity, let us understand what has led to increased liquidity. Here are a few reasons that could contribute to a liquidity upsurge.• Increase in small savings receipts and public provident funds .• Provisional delay of capital expenditure.• Increase in foreign investment (equity and debt.)• Rise in advance tax receipts.• Capital inflow from NRI deposits.SDF provides flexibility to manage surplus liquidity by freeing the RBI from the need to disclose government securities on the balance sheet. SDF will include two entries on the balance sheet, one being net claims on banks and the other being currency-in-circulation. The resulting effect will allow the RBI a better chance to absorb liquidity. Also, the overnight deposits, subject to the SDF rate, will be at a rate lower than the repo rate. However, with the correct pricing, the RBI can absorb long-term liquidity when required.SDF is a financial tool that allows banks to deposit excess liquidity with the RBI without any security or collateral. The RBI introduced this tool to absorb and manage excess liquidity. Any change in policy rates can influence your loan interest and deposit rates. Therefore, you must stay updated about SDF rates and other factors, such as repo rates. Also read: Everything You Need to Know about Statutory Liquidity Ratio (SLR)