What is a Standing Deposit Facility (SDF), and How Does It Work?

When banks have extra money, what do they do with it? SDF is a mechanism that helps manage such extra liquidity in the economy. Standing Deposit Facility (SDF) is a monetary policy tool introduced by the Reserve Bank of India (RBI) on April 8, 2022,. It aims to absorb excess liquidity from the banking system. SDF allows banks to temporarily deposit their surplus funds with the RBI without any collateral and earn an interest rate on it. However, why does our economy need a facility like SDF? 

In this blog, we will share all the basics surrounding the Standing Deposit facility, the SDF rate, and the need for SDF RBI for liquidity management.

Understanding the Standing Deposit Facility

SDF Full Form- Standing Deposit Facility. 

Standing Deposit Facility is a mechanism that was introduced by RBI in 2022. It is like a special account where commercial banks can temporarily deposit their extra money with the RBI. 

But why would they do that?

The RBI pays them an interest rate for using this facility, which is called the SDF rate. 

This standing deposit facility helps the RBI manage the total amount of money circulating in the economy. It aims to prevent and control inflation. 

In simple terms, SDF is like a secured deposit facility for banks to keep their extra money, and the SDF rate is the interest they earn for doing so.

Why did the RBI introduce SDF?

The RBI introduced SDF as a way to manage liquidity in the economy, especially in the wake of the COVID-19 pandemic, which resulted in a huge influx of funds into the banking system. 

The excess liquidity in the system poses a challenge for the RBI. It can create inflationary pressures and cause hindrance in the implementation of monetary policy.

SDF RBI acts as the support tool to the existing monetary policy tools like marginal standing facility, cash reserve ratio, reverse repos, and open market transactions. 

1. LAF corridor: It is an important indicator of the monetary policy of the RBI. It influences the short-term interest rates in the money market. 
2. Repo rate: It is the interest rate at which RBI lends money to commercial banks for a short term. This loan is provided against the collateral of government securities. 
3. Reverse repo rate: It is the interest rate at which RBI borrows money from the commercial banks for a short term by selling government securities.
4. Marginal standing facility (MSF): It is a scheme that helps banks borrow overnight funds from the RBI by pledging government securities at a higher rate than the repo rate.

SDF and MSF: Standing Deposit Facility  vs Marginal Standing Facility 

The Standing Deposit Facility (SDF) and the Marginal Standing Facility (MSF) are both tools used by the Reserve Bank of India for liquidity management. 

However, they serve opposite purposes:

Standing Deposit Facility (SDF) aims to absorb excess liquidity from banks. It doesn’t require a collateral.

Marginal Standing Facility (MSF) aims to provide emergency liquidity to banks. However, it does require government securities as collateral.

Features of Standing Deposit Facility Scheme- 

Standing Deposit Facility (SDF) – Scheme Overview- 2024

1. The SDF scheme was introduced on April 8, 2022.

2.  All participants in the Liquidity Adjustment Facility (LAF) can take part in the SDF scheme.

3.  Entities eligible for SDF can place overnight deposits with the RBI. The RBI also has the flexibility to absorb liquidity for longer periods, as needed.

4.  The overnight SDF facility is accessible from 17:30 to 23:59 on all days, including Sundays and holidays. 

5.  The interest rate on deposits under the SDF is determined by the RBI and is set at 25 basis points below the policy repo rate, i.e., at 3.75% starting April 8, 2022.

Hereby, since the current Repo Rate in India, fixed by RBI, is 6.50%, the current SDF rate is 6:25%.

Now, How does SDF work?

SDF works as an overnight facility, which means that banks can deposit their excess funds with the RBI for one day and get them back the next day. 

The SDF is available to all:

Scheduled commercial banks, regional rural banks, small finance banks, payments banks, local area banks, urban cooperative banks, district central cooperative banks and even the state cooperative banks. 

The banks can access the SDF through the RBI’s e-Kuber system, which is the core banking solution of the RBI. 

Benefits of SDF: Role of Standing Deposit Facility in Liquidity Management

SDF provides banks with flexibility.  It also lessens dependence on reverse repo, which requires collateral. 

SDF has several benefits for the RBI, the banks, and the economy. 

Some of the benefits are:

• Monetary Policy Effectiveness

SDF enhances the usefulness of the RBI’s monetary policy. This helps the RBI to maintain price stability and support economic growth.

• Policy Rate Transmissions: 

SDF improves the transmission of the RBI’s policy rates to the market rates by widening the LAF corridor. This reduces the cost of borrowing for the banks and their customers and promotes credit demand and investment.

• Overall Liquidity Management

SDF tool provides an attractive and risk-free option for the banks to park their excess funds. This improves the profitability and liquidity position of the banks.

•  Market Stability

SDF reduces the volatility and uncertainty in the money market. This enhances the efficiency and stability of the financial system and fosters financial inclusion.

Reverse Repo Rate and Standing Deposit Facility (SDF): How Do They Differ

Here is the table summarising the differences between the reverse repo rate and Standing Deposit Facility (SDF):

Basis	Reverse Repo Rate	SDF
Meaning	The interest rate at which the RBI borrows money from commercial banks by depositing collateral or government securities	The interest rate at which the RBI absorbs excess liquidity from commercial banks without any collateral
Purpose	To inject liquidity into the economy by encouraging banks to lend their surplus funds to the RBI	To absorb liquidity from the economy by encouraging banks to park their excess funds with the RBI
Rate	Lower than the repo rate, currently set at 3.35%	Higher than the reverse repo rate, currently set at 6.25 %
Impact of the increase in the rate	It discourages banks from transferring money to the RBI and increases the availability of funds in the market	It encourages banks to transfer money to the RBI and reduces the availability of funds in the market

How Does SDF Affect Liquidity?

Here are some factors that can lead to higher liquidity:

• Growth in small savings and public provident funds.
• Delays in government capital spending.
• Increased foreign investments (in both equity and debt).
• Higher advance tax payments.
• More deposits from Non-Resident Indians (NRIs).

The SDF creates two entries on the balance sheet: net claims on banks and currency in circulation. This setup helps the RBI absorb liquidity better. Also, overnight deposits under the SDF earn interest at a rate lower than the repo rate. With proper pricing, the RBI can also manage long-term liquidity when needed.

Conclusion

SDF is expected to enhance the effectiveness of the RBI’s monetary policy. It also aims to promote investment in the economy. However, SDF may affect the demand and supply of government securities and discourage the banks from lending to the private sector.

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FAQs| SDF- Standing Deposit Facility

Source- rbi.org.in, rbi.org.in

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Disclaimer: Investments in the securities market are subject to market risks; read all the related documents carefully before investing.