RBI panel for standing deposit facility

The Reserve Bank of India8217;s RBI internal group on liquidity adjustment facility LAF has proposed a standing deposit facility to len...

The Reserve Bank of India8217;s RBI internal group on liquidity adjustment facility LAF has proposed a standing deposit facility to lend more flexibility to the central bank in using the repo facility as a signalling device and to mop up surplus funds emanating from settlement balances of banks in an RTGS real-time gross settlement environment.

The group is also for linking the bank rate to the reverse repo rate and has underscored the need for setting up a market stabilisation fund MSF as a sterilisation option before the RBI as proposed by its Working Group on Instruments of Sterilisation.

The institution of a deposit facility, which is distinct from cash reserve ratio CRR, however, needs amendment to the RBI Act 1934. The Act, in its present form, does not permit the central bank to borrow on a clean basis from banks and pay interest thereon. It was felt that pending amendments to the RBI Act, the RBI should explore possibilities of modifying the current CRR provision to accommodate a standing deposit type facility for scheduled banks within its ambit which could achieve the same objective as a standing deposit facility. Such deposits may be deemed as part of CRR with a flexible interpretation of RBI Act8217;s extant provisions.

The group has suggested that banks should earn lower interest rate than the repo rate while exercising this 8216;standing type facility8217; option. This is because 8220;the interest rate on standing deposit type facility is designed to provide a floor to the interest rate corridor8221;.

It is of the view that banks should have the discretionary power in placing deposits under this facility, unlike in the case of CRR. This facility will also give banks the power to manage their liquidity better.

It could be recalled that the RBI had already made proposals to the Centre to have the flexibility to change CRR even below the current statutory minimum of three per cent as also to pay interest on such balances actually maintained with it by scheduled banks. It noted that such amendments are required in the light of the evolving monetary policy framework.

The group recommended alignment of the interest rate on CRR with the desired interest rate on the proposed standing deposit type facility and the rate also be delinked from the Bank Rate and placed at a rate lower than the repo rate.

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The RBI, in its mid-term review of monetary and credit policy for 2003-04, had hinted that the LAF operation had been under revision against the backdrop of the recent market and technological developments. The draft report of the group was discussed both in the Technical Advisory Committee on Money and Government Securities Markets TAC and the Financial Markets Committee FMC of RBI. The report is now placed in public domain for wider comment and debate.

This facility would also help the central bank in using the repo facility as a signalling device while not sacrificing the objective of the provision of a floor to the movement of short-term interest rates.

The suggestions of the group also include reducing the minimum tenor of the repo/reverse repo operations under LAF to seven days from the current system of overnight repo. But the group viewed that even when the overnight repo is phased out, the RBI should have the option of conducting overnight repo if the situation demands.

In the proposed framework, it has been recommended that the LAF auction could be a fixed rate auction enhancing its policy signalling rate. 8220;However, the RBI should have the flexibility to use the variable price auction format if the situation so warrants,8221; the group added.