RBI liquidity explained: why the central bank lent cash on Monday after draining it all week

Every bank in India ends each day with either too much cash or too little, and the Reserve Bank of India’s job is to even that out. On Monday, November 9, the RBI lent banks ₹50,003 crore for four days, only days after it had been taking cash out of the system. The two moves are not a contradiction. They are the same tool used in opposite directions.

What is liquidity?

It is the cash banks hold in their accounts with the RBI to settle payments with each other. Banks must also keep a share of their deposits there as the cash reserve ratio, and since October 16 the daily balance has to be at least 99% of the requirement, not 90%.

When banks together hold more than they need, they lend the extra overnight to one another cheaply, and the rate they charge, the call rate, falls below the policy rate. When they hold too little, the call rate climbs above it. The RBI wants the call rate near the 5.50% repo rate, because that is the rate the Monetary Policy Committee set when it raised it on October 7, its first rise since February 2023.

The tools

The repo is the RBI lending to banks. A bank hands over government bonds and gets cash, agreeing to buy the bonds back later at a slightly higher price, which works out as interest. The reverse repo is the opposite: the RBI takes cash from banks and gives bonds as security.

Both are often run as variable rate auctions. In a variable rate repo (VRR) or variable rate reverse repo (VRRR), the RBI announces an amount and a length, from overnight to several weeks, and banks bid with the rate they will pay or accept. Bids at the cut-off rate may be filled only in part, as happened on Monday when only 15.18% of the money sought at 5.51% was allotted.

Two standing doors sit on either side. The standing deposit facility (SDF) lets banks park any amount with the RBI overnight at 5.25%, with no bonds needed. The marginal standing facility (MSF) lets them borrow overnight against bonds at 5.75%, a penalty for emergencies.

What the RBI did in the past month

Banks had far more money than they needed. On October 8 the surplus parked with the RBI was ₹3.88 lakh crore. The call rate had been averaging about 14 basis points below the repo rate since August, which blunted the rate rise: a bank that could borrow at 5.31% had little reason to pay 5.50%.

The RBI’s response was to drain. It raised the daily cash reserve minimum, announced ₹25,000 crore of government bond sales and ran reverse repo auctions. On November 4 it took in ₹50,015 crore in one overnight auction and ₹1,180 crore in another, both at 5.49%. On November 6 a three-day auction took in ₹18,133 crore, against ₹25,000 crore offered.

Why it reversed

The cushion shrank. Banks’ deposits with the RBI under the SDF fell from ₹2.02 lakh crore on November 6 to about ₹1.5 lakh crore at the weekend, well under half of the October surplus. The RBI’s tables still showed net absorption of ₹1.55 lakh crore, so the system is not short of cash. But some banks wanted money for several days at a price near the policy rate, and the RBI was willing to supply it at 5.51%.

The RBI gave one reason for the auction: “a review of current and evolving liquidity conditions in the near term”. It did not say more. Reading the move as a sign that the RBI wants short-term rates to sit at or just above the repo rate fits the aim of the October hike, but that is an interpretation, not an RBI statement.

Why it matters to a borrower

Loans linked to the repo rate move when the policy rate moves, and the market rates for short-term money decide whether the hike is fully felt. If the call rate stays below the repo rate, banks that fund themselves overnight pay less than the policy rate suggests, and the tightening is weaker than intended. Several state-run banks have already passed on the 25 basis point rise in their repo-linked lending rates.

Fixed deposit and loan rates do not follow the daily auction. But a central bank that keeps the overnight rate where it said it would is a central bank whose rate decisions carry weight.

What to watch

The money lent on Monday returns to the RBI on Friday, November 13. The current reporting fortnight ends on November 15. Further auctions are announced a day or so ahead on the RBI’s website, and the Monetary Policy Committee next meets from December 2 to 4.