The Reserve Bank of India (RBI) on Thursday revised the existing liquidity management framework through which it ensures adequate liquidity in the system so that sufficient credit is provided to all productive sectors in the economy.
According to the revised framework, RBI has finalized weighted average call rate (WACR) as the single operating target and withdrawn the current provision of maintaining assured liquidity of 1% of net demand and time liability (NDTL). The call rate is the interest rate at which banks lend overnight money to each other. With this move, RBI is looking to target call rate and keep it near the repo rate so that better transmission happens. Earlier RBI had to maintain 1% NDTL liquidity to ensure that inter-bank call rate is near the repo rate. Current NDTL stands at ₹1.3 trillion. Liquidity in the banking system is currently estimated at a surplus of a massive ₹3.6 trillion.
“With the WACR being the single operating target, the need for specifying a one-sided target for liquidity provision of 1% of net demand and time liabilities does not arise. Accordingly, the daily fixed rate repo and four 14-day term repos every fortnight being conducted, at present, are being withdrawn. However, the Reserve Bank will ensure adequate provision/absorption of liquidity as warranted by underlying and evolving market conditions—unrestricted by quantitative ceilings—at or around the policy rate,” said the policy.
Under the new framework, RBI has withdrawn the daily fixed rate repo and 14-day term repos and, instead, introduced a variable 14-day term repo/reverse repo operation, which will be conducted to coincide with the cash reserve ratio maintenance cycle.
“Banks cannot go to RBI for daily repo. Instead on a fortnightly basis the 14 day repo will be aligned with reporting Friday when banks have to square off the CRR balance,” said a senior banker at a bank.
With these changes, RBI has also assured of using all instruments to ensure that adequate liquidity is available at all times.
“Instruments of liquidity management will include fixed and variable rate repo/reverse repo auctions, outright open market operations, forex swaps and other instruments as may be deployed from time to time to ensure that the system has adequate liquidity at all times,” RBI said.
Under the new framework, RBI also says that liquidity management corridor is retained, with the marginal standing facility (MSF) rate as its upper bound (ceiling) and the fixed rate reverse repo rate as the lower bound (floor), with the policy repo rate in the middle of the corridor. The width of the corridor remains unchanged at 50 basis points (bps)—the reverse repo rate being 25bps below the repo rate and the MSF rate 25bps above the repo rate. MSF provides a safety valve to banks against unanticipated shocks to borrow overnight from RBI.
To improve communication on the Reserve Bank’s liquidity management framework and procedures, RBI said press releases detailing money market operations would be modified to show both the daily flow impact as well as the stock impact of the liquidity operations. A quantitative assessment of durable liquidity conditions of the banking system on a fortnightly basis would be published with a lag of one fortnight and periodic consultations will be conducted with market participants and other stakeholders.
Over the last two weeks, the weighted average call rate had drifted towards the reverse repo rate, the lower bound of the monetary policy corridor, effectively bringing down cost of funds of banks just as a rate cut would have.