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New step to manage liquidity

Mumbai, Dec. 2: Banks could soon be allowed to keep deposits over and above the required cash reserve ratio (CRR) with the Reserve Bank of India (RBI).

The central bank today indicated that it might come out with a new instrument in the form of standing deposit-type facility to manage liquidity. The suggestion came through in an internal report the central bank had called for to revamp the liquidity adjustment facility (LAF) and enlarge the effectiveness of monetary operations.

The facility enables the Reserve Bank to modulate short-term liquidity. It operates through daily repo and reverse-repo auctions, setting a path for short-term interest rates.

The report underscores the need to switch to international practices, suggesting that India replace its current definition of repo and reverse-repo deals with those adopted overseas. Internationally, while repo denotes injection of liquidity by the central bank against eligible collateral, reverse-repo means absorption of liquidity under the same set of conditions.

By contrast, in the Indian context, repo denotes liquidity absorption by the Reserve Bank and reverse-repo denotes liquidity injection. “In order to achieve uniformity and facilitate international comparison, it would be useful to follow international practice in the use of the terms repo and reverse-repo,” the report said.

But the most important suggestion came in the form of a standing deposit facility, which can come in by modifying the current CRR provision. The RBI said that liquidity management apart, this is a more efficient instrument as it can distinguish between banks having surplus cash balances from those that are in deficit.

Further, banks can go for these deposits if they wish to, unlike the cash-reserve ratio that they are required to meet irrespective of their liquidity position.

“Introduction of a deposit facility becomes essential to afford more flexibility to RBI in using the repo facility as a signalling device, while not sacrificing the objective of the provision of a floor for the movement of short-term interest rates,” the panel said.

The RBI said since the interest rate on standing deposit-type facility is designed to serve as a floor for short-term interest rates, the return on them should be lower than the repo rate in force at a point of time.

The group suggested that rate given to banks on CRR balances kept with the RBI may be aligned with the desired interest on the proposed standing deposit-type facility. It was also felt that yield on eligible cash balances should not be tied to the bank rate since it is not justifiable.

The panel was of the belief that the minimum tenor of the repo/reverse-repo operations under LAF facility should be changed from overnight to seven days.

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