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The Reserve Bank of India (RBI) is understood to have broached the possibility of conducting Long Term Variable Rate Reverse Repo (LTRR) auctions with banks in the run-up to the normalisation of its ultra-accommodative policy.
The central bank is exploring LTRR as an instrument to absorb surplus liquidity for a longer duration from the banking system at a time when credit demand is muted, and retail inflation is sticky.
LTRR is one of the instruments to manage durable liquidity under the RBI’s revised Liquidity Management Framework. It has a tenor of over 14 days.
However, banks are wary of locking-up liquidity for longer tenors of, say, a month or two under LTRR because in case credit demand gains steam, they will have to tap funding options such as the central bank’s repo (repurchase agreement) window, certificate of deposits, among others, to meet their demand. They may even have to increase fixed deposit rates.
Banks have indicated to the RBI that they prefer investing in treasury bills of 91 days, 182 days and 364 days duration as the bills can be easily liquidated to fund future demand for loans. However, if they invest in LTRR, this flexibility will not be available.
Banks awash with liquidity
That banks are awash with liquidity is underscored by the fact that they collectively parked ₹6,53,431 crore with the RBI’s reverse repo window on August 4, 2021. Banks earn 3.35 per cent interest (reverse repo rate) on this amount.
Further, at the last 14-day Variable Rate Reverse Repo (VRRR) auction held on July 30, 2021, the RBI received bids to park surplus liquidity aggregating to ₹3,67,428 crore against the notified amount of ₹2 lakh crore.
The central bank accepted bids aggregating to ₹2,00,033 crore, with the weighted average interest rate that banks will receive working out to 3.43 per cent.
Radhika Rao, Senior Economist, DBS, observed that the RBI’s preference to gradually draw out excess liquidity might increase the sizes of variable reverse repo rate (VRRR) auctions while reaffirming support for the ongoing Government Securities Acquisition Program.
As per Rao’s assessment, the impact of a VRRR increase might be marginal given the scale of surplus liquidity (estimated at ₹7.5-8 lakh crore) – bank liquidity plus government cash balances.
Nonetheless, it affirms the central bank’s intent to mop-up liquidity at a calibrated pace before setting the stage for a reverse repo increase and change in policy stance around the end of 2021 or early 2022, she said.
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