RBI Releases Internal Working Group Report On Liquidity Management Framework

The Reserve Bank of India's internal working group has proposed a significant revamp of the central bank's liquidity management operations.

While it has retained its stance that the weighted average call rate will remain as the core anchor for monetary policy transmission, it has also suggested the shift to 7-day variable rate repo operations and shorter tenors to manage transient liquidity.

Last week, NDTV Profit exclusively reported that the RBI was to announce a revised liquidity management framework in its August policy.

The central bank had met with market participants, including senior bank officials, primary dealers and economists last week, NDTV Profit had said.

The panel, led by Deputy Governor Dr. Poonam Gupta, submitted its report after reviewing the effectiveness of the current liquidity management framework in place since 2020. RBI has invited comments on the same from stakeholders and public through email by August 29.

The review comes against the backdrop of global monetary shocks, structural changes in India's financial system, and increasing volatility in capital flows.

Among the recommendations from the report was that weighted average call rate remains as the operating policy target.

The group acknowledged the sharp decline in the call money market's share, with volumes declining to 2% during 2022-2025 from 16% since 2011 but said that remains the most effective operating target.

"...targeting the uncollateralised rate provides a clear signal to financial markets about the central banks' desired level of interest rates...a stable and predictable uncollateralised rate facilitates a more effective transmission of monetary policy," the report said.

The group has recommended that 14-day variable rate repo or variable rate reverse repo auctions may be discontinued as the main operation.

Instead, the transient liquidity may be managed primarily through 7-day repo or reverse repo operations and other operations of tenors from overnight up to 14-days at the discretion of the RBI based on its assessment of the system liquidity requirement.

Further, to reduce uncertainty in the market about the tenor, quantum and timing of the repo or reverse repo operations, the group felt that it is desirable for RBI to provide sufficient advance notice to market participants, at least by one day, while conducting any such liquidity operation.

The group observed that there may be situations in which the evolving liquidity conditions may warrant conduct of liquidity operations on the same day of announcement.

The group has recommended that in such circumstances, RBI may conduct these repo or reverse repo operations announced on the same day.

"The Group noted that the set of instruments in the extant LMF, viz., Open Market Operations (OMOs), long-term VRR/VRRR operations and Foreign Exchange (FX) swap auctions, are sufficient for managing durable liquidity in the system and hence does not recommend any change at this stage," the report said.

The group has also recommended the RBI to retain the extant daily minimum requirement of 90% of the prescribed cash reserve ratio.

This has come as the RBI believes that there is a view that some reduction in the 90% daily maintenance requirement is warranted as it may provide further room for banks to effectively manage their liquidity over the maintenance period.

Averaging of reserve requirement over the maintenance period allows banks to use excess reserves from one day to offset shortfall on other days. In the context of 24x365 payment systems, which has resulted in banks building up precautionary reserve balances, there is a view that some reduction in the 90 per cent daily maintenance requirement is warranted.

However, lowering daily CRR maintenance requirement may induce higher volatility in money market rates, especially during end of fortnights, which may not be desirable. It has also been observed that banks rarely maintain daily reserve balances below 95%.

The group has recommended continuation of the existing liquidity corridor system with policy repo rate at the middle of the corridor.

The corridor would remain symmetric, with standing deposit facility rate and marginal standing facility rate, which are 25 basis points away from the policy repo rate, acting as the lower and upper bounds of the corridor, respectively.

While widening the corridor can encourage relatively higher inter-bank activity, it may lead to increased day-to-day volatility in the short-term market rates, the report said.

On the other hand, a narrow corridor may provide the advantage of better anchoring of short-term market rates but comes at the cost of reduced incentives for banks to indulge in inter-bank trading.