Explained | RBI allows reversal of liquidity measures under both SDF, MSF on weekends, holidays: What does it mean?

The Reserve Bank of India (RBI) has two powerful liquidity adjustment tools: the Standing Deposit Facility (SDF) and the Marginal Standing Facility (MSF). In its bi-monthly policy review of December 2023, the central bank permitted a reversal of liquidity facilities under SDF and MSF even on weekends and bank holidays, with effect from December 30, 2023.

What is the move?

What it essentially means is that commercial banks—which could park funds in SDF and borrow from MSF on holidays but were only allowed to reverse those transactions on working days—will be allowed to make a U-turn on such transactions even during weekends and bank holidays, and this change will come into force on December 30 and will be reviewed every six months.

Why the move?

The measure is aimed at promoting better liquidity management in the country's banking system.

But first things first, what are the SDF and MSF tools really? 

Liquidity Adjustment Facility (LAF)

The LAF came to exist as a result of the Narasimham Committee on Banking Sector Reforms in 1998. Primarily, LAF allows banks to raise finance through repos or repurchase agreements or to lend money to the apex bank through reverse repo agreements. The measure ensures financial market stability.

Standing Deposit Facility (SDF) 

It is an overnight facility that enables banks to transfer excess liquidity and earn a higher rate of interest. This is a better and more efficient method in comparison to the reverse repo method where G-Securities are sold and then re-purchased to absorb liquidity.

Marginal Standing Facility (MSF)

Commercial banks can borrow money for a short term through the MSF route to mitigate their liquidity woes. Taking this route, banks borrow funds from the RBI for a day by offering dated government securities. 

Now that we have learned the basics of these technical terms, here is what RBI announced in its December 8 statement.

“With regard to the standing facilities of the Reserve Bank under the LAF, we have noticed simultaneous high utilisation of both MSF and SDF by the banks. This was pointed out in the last monetary policy statement. We propose to address this situation and have decided to allow reversal of liquidity facilities under both SDF and MSF even during weekends and holidays with effect from December 30, 2023. It is expected that this measure will facilitate better fund management by the banks. This measure will be reviewed after six months or earlier, if needed,” stated the RBI Governor. Read the full text of Shaktikanta Das's speech on December 8

What does this reversal of MSF and SDF mean for commercial banks?

While the liquidity conditions are already tight, the reversal of liquidity under MSF and SDF will resolve the operational issue at the end of banks and money market participants, explains Suman Chowdhury, Chief Economist and Head-Research at Acuite Ratings & Research. “An operational issue for banks and money market participants has been resolved by permitting balance adjustments to the MSF and SDF during holidays and weekends. This will help in normalising the sharp swings in system liquidity and prevent excessive volatility in call money or other short-term rates,” according to Chowdhury. 

The system liquidity tightened significantly than what the MPC envisaged in the October policy, therefore, the need for OMO auctions did not arise. At this juncture, the RBI noticed that banks actively used the SDF and MSF option, and pointed out the same in the policy meeting. 

Additionally, the net position under the LAF turned into deficit mode for the first time in September 2023 after a gap of nearly four and a half years since May 2019.

“Deficit liquidity conditions persisted during October and November prompting large recourse to the MSF by banks. In parallel, utilization of the SDF has also been high. The overall tightening of liquidity conditions is attributed mainly to higher currency leakage during the festive season, government cash balances and Reserve Bank’s market operations,” the RBI Governor said.

“Therefore, in a move that tweaks the liquidity management of banks, the RBI has now allowed banks reversal of liquidity facilities under SDF and MSF even during holidays and weekends. This decision would allow better fund management for the banks,” adds Omkar Kamtekar, Research Analyst at Bonanza Portfolio.