What is a Standing Deposit Facility (SDF)?

Key Highlights

• To absorb extra liquidity from banks by means of interest payments, the Standing Deposit Facility is a collateral-free liquidity absorption mechanism implemented by the RBI.
• On April 8, 2022, the SDF was introduced.

Understanding What is Standing Deposit Facility?

The Standing Deposit Facility allows the Reserve Bank of India to remove liquidity from commercial banks without making available government bonds in return for bank deposits. The working-horse reverse repo mechanism is currently the most important arrangement between the Reserve Bank of India and the banking system to absorb excess money. When the Reserve Bank of India gives banks excess cash, they receive government securities in return under reverse repo, which is part of a liquidity adjustment facility.

Banks are provided with an interest rate on the reverse reposal rate. Essentially, the Reserve Bank of India has introduced a Stabilization Deposit Facility as an overnight facility, which implies that banks can deposit money with the central bank for one day. However, a longer duration of SDF can be introduced by the RBI.

Features of Standing Deposit Facility

The features of a standing deposit facility are as follows:

1. The facility for standing deposits, the Fixed Rate Reverse Repo (FRRR), would be replaced by the SDF as the LAF corridor's floor.
2. The SFF rate shall be 25 basis points less than the policy repo rate.
3. The SDF is a liquidity absorption facility, and the Reserve Bank of India might be able to increase its duration at any time.
4. The SDF facility can be used by any entity that is eligible for the LAF.
5. Working time: The SDF is a highly important feature, as are the MSFs, which will be available throughout the day and during weekends and holidays.
6. The Reserve Bank of India decides the interest rate on a periodic basis, and currently, it's kept 20 basis points lower than the policy repo rate.
7. The operation of the SDF will be carried out on the RBI eKuber system, which operates by electronic means.

Importance of Standing Deposit Facility

The aim of the SDF is that it should enable the Reserve Bank to tackle extremely difficult situations in which significant amounts of liquidity are needed. Previous situations, such as the global financial crisis and demonetisation, have caused liquidity absorption problems for the Reserve Bank of India.

Reverse repos, open market transactions, and the cash reserve ratio (CRR) are all methods of liquidity absorption that the Reserve Bank may choose to use under the current liquidity framework. However, the SDF would give banks the option to store any excess liquidity with the Reserve Bank. The SDF is a standing facility that supports the Marginal Standing Facility (MSF) (MSF for liquidity injection, SDF for liquidity absorption).

How does SDF impact liquidity?

One of the most important questions raised by SDF's introduction is what effect it will have on liquidity. Let us know what has caused the increase in liquidity before we can figure out how much it's going to take up. A number of the possible reasons for this increase in liquidity are given below.

Increasing the amount of advance tax revenues Increase in slight savings collections and public provident funds. Capital expenditures need to be temporarily postponed. Increasing investments in equity and debt from foreign portfolios NRI deposits and trade credit are the net capital inflows.

The SDF enables the management of surplus liquidity to be flexible as it abolishes the rule that the RBI must display government securities on its balance sheet. There will be two entries for each SDF on the balance sheet: one under assets, net claims on banks, and the other under liabilities, currency in circulation. With this reduction in the impact on the central bank's balance sheet, there is a greater possibility for the RBI to carry over surplus liquidity.

Conclusion

SDF is a financial mechanism that enables banks to deposit their liquidity with the RBI without providing any kind of security. As it plays a significant role in setting policy interest rates, the Reserve Bank of India has introduced this tool to manage excessive liquidity in the market. You must know that this policy rate change will influence your deposit and loan interest rates. Therefore, with the repo rate and others, you must keep an eye on SDF rates. To start stock trading and to open any kind of account, check out Kotak Securities trading platform.