Reverse Repo & Liquidity Tools
Notes
Reverse repo is the opposite of repo: the RBI borrows money from banks by selling G-secs to them (with an agreement to buy back), which absorbs surplus liquidity from the system. The reverse repo rate is the rate the RBI pays.
Evolution
- Earlier the reverse repo rate was below the repo rate and served as the floor of the corridor.
- In April 2022 the RBI introduced the Standing Deposit Facility (SDF), a collateral-free facility with the rate at repo minus 0.25%, as the new floor. The Fixed Rate Reverse Repo (FRRR) rate was kept separate (a lower rate), and the RBI uses Variable Rate Reverse Repo (VRRR) auctions to absorb liquidity.
Other liquidity tools
Tool | What it does |
|---|---|
Liquidity Adjustment Facility (LAF) | Daily repo and reverse repo operations (introduced in 2000 on the Narasimham Committee recommendation) to adjust liquidity |
Variable rate repo / reverse repo | Auctions of different tenors (such as 14-day) to manage liquidity |
Marginal Standing Facility (MSF) | Overnight borrowing by banks against SLR securities (up to 2-3% of NDTL) at repo plus 0.25%; introduced in 2011 for emergencies |
Bank Rate | The rate at which the RBI gives long-term loans without collateral; equal to the MSF rate (since 2011); also used for penalties |
Cash Reserve Ratio (CRR) | A share of NDTL kept with the RBI in cash (Section 42 of the RBI Act); no interest paid |
Statutory Liquidity Ratio (SLR) | A share of NDTL maintained by banks in liquid assets (cash, gold, G-secs) (Section 24 of the Banking Regulation Act, 1949) |
Open Market Operations (OMO) | Outright purchase (injects liquidity) or sale (absorbs) of G-secs; Operation Twist swaps short- and long-term securities |
Market Stabilisation Scheme (MSS) | Securities issued (2004) to sterilise excess liquidity, mainly forex inflows |
Forex swaps | Buy/sell dollar-rupee swaps to add or remove rupee liquidity |
Liquidity conditions: surplus (RBI absorbs through reverse repo or VRRR or SDF) or deficit (RBI injects through repo, OMO purchases or swaps).
Key Points
- Reverse repo: the RBI borrows from banks; absorbs liquidity.
- SDF (April 2022) is now the floor of the LAF corridor, at repo minus 0.25%.
- LAF introduced in 2000; MSF in 2011.
- CRR: cash with the RBI; SLR: liquid assets with banks.
- OMO and MSS also manage liquidity.
MCQs
Q1. When the RBI wants to absorb excess liquidity, it uses: (a) Repo operations (b) Reverse repo operations (c) Lowering the CRR (d) Buying securities in OMO Ans: (b).
Q2. The Standing Deposit Facility rate is: (a) Repo plus 0.25% (b) Repo minus 0.25% (c) Equal to repo (d) Equal to the bank rate Ans: (b).
Q3. Buying government securities in open market operations by the RBI: (a) Absorbs liquidity (b) Injects liquidity (c) Has no effect (d) Raises the CRR Ans: (b).