SDF might actually squeeze banking sector’s margins at this point: Yes Bank’s Pan

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The recently introduced standing deposit facility (SDF) might lead to squeezed margins for the banking sector at this point, Yes Bank chief economist Indranil Pan said on April 12.

Reserve Bank of India (RBI) Governor Shaktikanta Das on April 8 announced the introduction of SDF as the basic tool to absorb excess liquidity under the new monetary policy. Economists have called it an alternative to the reverse repo rate as the RBI has been driving the market away from the reverse repo. The SDF will help the central bank in absorbing liquidity (deposits) from commercial banks without giving government securities in return.

The SDF will be at 3.75 percent, 0.25 percentage point below the repo rate, and 0.50 percentage point lower than the marginal standing facility (MSF) which helps banks with funds when required. Pan said there have been instances when the RBI has faced challenges in terms of liquidity management and SDF is a way to counter those challenges.

“When the RBI absorbs liquidity from the money market, it has to give securities to the banking system and if the liquidity surplus is so huge, the RBI may run out of assets that they provide to the banking sector. This has traditionally been a problem with the RBI,” Pan said.

India may not be facing any liquidity issue currently, but the RBI has introduced this financial tool keeping in mind the economy’s long-term goal.

“The RBI would like to downsize their balance sheets. If at a point of time there is too much liquidity in the system, this is the tool whereby they can absorb the liquidity without being constrained by the amount of assets that they hold against the liquidity that they want to absorb,” said Pan.

The idea of an SDF was first mooted in the Urjit Patel Monetary Policy Committee report in 2014, which later received the government’s nod following an amendment to the RBI Act in 2018, vide the Finance Bill.

Since then, the central bank has proposed introducing the SDF for liquidity management so that banks can park as much money with it as they want without getting collateral, and at a lower rate than the reverse repo rate. The RBI again dusted off the idea of introducing the SDF when the pandemic hit in 2020 too but no decision was taken at that time.