MC Explainer| All you need to know about standing deposit facility

Reserve Bank of India

Reserve Bank of India (RBI) Governor Sanjay Malhotra while announcing the monetary policy showed concern that banks, instead of lending funds in the uncollateralised call money market, are parking it in the standing deposit facility (SDF).

This is happening even as there is a huge liquidity deficit in the banking system, and as a result of the preference for SDF, the overnight call money rate has remained higher than the RBI’s repo rate. 

Here's more.

Let us first understand: what is SDF?

The SDF is a tool to absorb liquidity (deposits) from commercial banks without giving government securities to them in return. It replaced the reverse repo as a floor for liquidity adjustment facility or LAF corridor.

It was introduced by the central bank on April 8, 2022, when liquidity was in huge surplus.

When the central bank has to absorb a tremendous amount of money from the banking system through the reverse repo window, it becomes difficult to provide the required volume of government securities in return. This happened during the time of demonetisation.

In this sense, the SDF is a collateral-free arrangement, meaning that the RBI need not give collateral for liquidity absorption.

Why do banks park funds in SDF?
Usually, when banks have the excess funds in their system, they deposit it with the RBI and earn some interest off it.

As SDF is collateral-free, RBI does not provide any securities to banks.

MC Explains

Why is the RBI concerned over banks parking funds in SDF?

The concerns over the banks parking excess funds in the SDF has emerged because it is happening when liquidity is greatly in deficit and overnight rates remain higher than the repo rate by 5-10 basis points.

What was the RBI nudge to banks?

"It has been observed that some banks are reluctant to on-lend in the uncollateralised call money market; instead, they are passively parking funds with the Reserve Bank," Malhotra said in his maiden monetary policy speech.

He further added that banks should actively trade among themselves in the uncollateralised call money market to make it deeper and vibrant for better signal extraction from the weighted average call money rate.

What will it do to the call money market?

If the funds in the SDF parked by the banks come to the call money market, it will help to ease the overnight interbank lending rate.