Context:
Liquidity deficit surges to a 4-year high of ₹1.47 lakh crore on tax outflows.
What is Liquidity?
- It is a measure of cash and other liquid assets available with banks to meet demands upon it.
- It usually consists of central bank reserves and government bonds.
- RBI controls liquidity in banking system through a Liquidity Adjustment Facility (LAF).
What is LAF?
- LAF is a monetary policy tool which it injects or absorbs liquidity into or from the banking system.
- Recommended by – Narasimham Committee on Banking Sector Reforms of 1998
- It is operated through Repo and Reverse Repo auctions.
- Additional instruments for liquidity management – Marginal standing facility, Statutory Liquidity ratio, Standing Deposit Facility, Cash Reserve Ratio etc.
What is Surplus vs. Deficit Liquidity?
On any given day, if the banking system is a net borrower from the RBI under LAF, the system liquidity can be said to be in deficit and if it is a net lender to the RBI, the system liquidity is in surplus.
What are the reasons behind Liquidity Deficit?
- Implementation of Incremental Cash Reserve Ratio (ICRR)
- Payments of advance tax and GST by businesses and hence shift of liquidity away from banking sector.
- Other reasons include selling of dollars by RBI, increase in credit demand due to the festive season, etc.
What are the impacts of Liquidity Deficit?
- Rise in interest rates for consumers.
- Less availability of credit for developmental activities.
- Increase in Deposit rates or Special Deposit Schemes from banks to get money.
- Increased cost of borrowed funds due to rise in Money Market Rates. E.g., Yields on Treasury bills or T-bills spiked recently due to tighter liquidity conditions.
Treasury bills are short term debt instruments which are issued by RBI on behalf of the central government. They are presently issued in 3 tenors – 91 days, 182 days and 364 days.
- Potential Repo rate change from RBI which will increase banks repo-linked lending rates and the marginal cost of funds-based lending rate (MCLR), resulting in higher loan interest rates for consumers.
- Reduced Demand which can further lead to contraction of economic activities.
- Increased RBI Difficulties in maintaining low borrowing costs for growth while continuing with its monetary tightening cycle.
| Differences between the Terms associated with Liquidity Management | |||
| Term (Rate) | Meaning | Collaterals | Function |
| Reverse Repo rate | It is the rate which RBI pays to Scheduled Commercial banks (SCBs) to park their excess funds with RBI. (It is available at RBI’s discretion.) | Yes (From RBI to Banks) | Tool to control inflation by absorbing liquidity. |
| Standing Deposit Facility | Newly introduced facility for SCBS to park their excess funds with RBI. (It is available at Bank’s discretion) | No | Tool for liquidity management and financial stability. |
| Repo rate | It is the rate at which RBI lends money to SCBS. | Yes (From Banks to RBI) | Tool to regulate liquidity in the economy |
| Marginal Standing Facility or MSF | It is a short-term borrowing window for SCBS to get overnight funds from RBI in case of serious cash shortage or the asset-liability mismatch. Its maximum limit is 2% of Banks Net Demand and Time Liabilities (NDTL). | Yes (From Banks to RBI) | Short-term loans from RBI to help SCBS. |
Source: Economic Times
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