New Delhi, March 25, 2017

The government is exploring the possibility of a new monetary facility — standing deposit facility — to suck up excess cash in the banking system, reports Banikinkar Pattanayak in New Delhi. The discussion featured prominently in a meeting of senior finance ministry officials with bankers on Friday, sources told FE. There was an unusual surge in deposits following demonetisation in November, triggering calls for fresh instruments to reduce the excess cash flows. The meeting discussed the possibility of such a facility that would absorb excess cash with banks at a rate lower than the repo rate, sources said.

In a letter to top bankers, the finance ministry has said: “To provide a floor for the new operating framework for absorption of surplus liquidity from the system but without the need for providing collateral in exchange, it was recommended that a (low) remunerated standing deposit facility may be introduced, with the discretion to set the interest rate without reference to the policy target rate.”

The excess cash would be deposited with the Reserve Bank of India (RBI). In the last review in February, the monetary policy panel kept the repo rate unchanged at 6.25%, citing upside risks to inflation, with the RBI changing its stance from “accommodative” to “neutral”.

“It may be recalled that the expert committee to revise and strengthen the monetary policy framework of RBI in its report of January 2014 had recommended inter alia to support the operating framework by adding some new instruments to the tool kit of monetary policy,” the ministry said in the letter to the bankers, asking them to be present at the meeting.

Economic affairs secretary Shaktikanta Das declined to comment on the deliberations of the meeting chaired by him. It’s not yet clear what the exact contours of the mechanism will be, if implemented.

Massive cash deposits with banks following the note ban have driven up liquidity to around Rs 4 lakh crore in March from Rs 2 lakh crore in January.

Any such move, however, is expected to drive down bonds, as it could tighten cash conditions in markets. Analysts feel if the central bank absorbs the extra cash at a lower rate than the repo rate, it could influence short-term market rates as well. This, in turn, could result in banks further lowering their lending rates.

Banks have already lowered their lending rates by around 0.8 percentage point since the note ban led to the massive floods of deposits with the banking system.

Currently, the central bank regulates liquidity through facilities, including the cash reserve ratio, repo and reverse repo, based on market rates.

[The Financial Express]