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

Standing Deposit Facility (SDF) is a monetary policy tool introduced by the Reserve Bank of India (RBI) on April 8, 2022, 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 for liquidity management in the nation.

Understanding the Standing Deposit Facility

SDF Full Form- Standing Deposit Facility (SDF). 

It is a mechanism that was introduced by the Reserve Bank of India (RBI) in 2022. SDF 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. 

How is this beneficial?

This standing deposit facility helps the RBI manage the total amount of money circulating in the economy and, thus, keeps a check and controls 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 an additional tool 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, as it can fuel inflationary pressures and hamper its monetary policy transmission. The RBI has to mop up the excess liquidity to maintain price stability and support economic growth. 

Now, the whole idea of introducing SDF is to assist in the smooth liquidity management in the economy. It acts as the support tool to the existing monetary policy tools like marginal standing facility, cash reserve ratio, reverse repos, and open market transactions. 

Here are certain terms that you must know:

• LAF corridor: It is an important indicator of the monetary policy stance of the RBI, and it influences the short-term interest rates in the money market. 
• Repo rate: It is the interest rate at which RBI lends money to commercial banks for a short term against the collateral of government securities. 
• 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.
• 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.

Thus, all in all, MSF(marginal standing facility) acts as the means for liquidity injection, and SDF acts as the means for liquidity absorption in the nation. 

• SDF is a collateral-free and flexible tool to absorb liquidity from the banks without any limit. 
• SDF also helps the RBI maintain the liquidity adjustment facility (LAF) corridor, which is the gap between the repo rate and the reverse repo rate.

By setting the SDF rate below the repo rate, the RBI has widened the LAF corridor and signalled a more accommodative monetary policy stance. 

Features of the SDF- Standing Deposit Facility Scheme- Shared by RBI

Standing Deposit Facility (SDF) – Scheme Overview:

1.  Effective Start Date:

The SDF scheme becomes operational starting April 8, 2022.

2.  Eligibility Criteria:

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

3.  Tenor:

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, with appropriate pricing.

4.  Timing:

The overnight SDF facility is accessible from 17:30 to 23:59 on all days, including Sundays and holidays. Reversals take place on the following working day in Mumbai.

5.  SDF Interest Rate:

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 RBI pays an interest rate of 6.25%(as of Dec 2023)  to the banks for their deposits under SDF. 

The SDF is available to all scheduled commercial banks, including 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. 

Starting December 30, 2023, changes have been made to how the Standing Deposit Facility (SDF) and Marginal Standing Facility (MSF) operate. Previously, these facilities were available for overnight use on all days, but reversals were only allowed on the next working day in Mumbai. 

Now, following an announcement in the Governor’s Statement on December 8, 2023, reversals for both SDF and MSF can occur during weekends and holidays. 

For banks, these changes mean greater flexibility in managing their liquidity. Previously, the Standing Deposit Facility (SDF) and Marginal Standing Facility (MSF) were only reversible on the next working day, limiting banks’ ability to adjust their positions over weekends and holidays. 

What are the Benefits of SDF: Role of Standing Deposit Facility in Liquidity Management

SDF provides banks with flexibility, enabling them to manage liquidity by depositing funds with the RBI at any time and for any duration. It also lessens reliance on reverse repo, which requires collateral and is limited to working days, making SDF a valuable instrument for the RBI to absorb liquidity without impacting its balance sheet or the availability of government securities.

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

Some of the benefits are:

• Monetary Policy Effectiveness: SDF enhances the effectiveness of the RBI’s monetary policy by enabling it to absorb excess liquidity without any collateral constraint. 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 and creating downward pressure on the short-term interest rates. This lowers the cost of borrowing for the banks and their customers and stimulates credit demand and investment.

• Overall Liquidity Management: SDF provides an attractive and risk-free option for the banks to park their excess funds with the RBI and earn an interest income. This improves the profitability and liquidity position of the banks and enables them to lend more to the productive sectors of the economy.

•  Market Stability: SDF reduces the volatility and uncertainty in the money market by creating a stable and predictable source of liquidity for the banks. 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

What are the Challenges of SDF?

SDF also poses some challenges for the RBI, the banks, and the economy. 

Some of the challenges are:

•  SDF may reduce the demand for government securities in the market, as the banks may prefer to deposit their funds with the RBI rather than buying government bonds. This may increase the borrowing cost for the government and affect its fiscal position.

•  SDF may discourage the banks from lending to the private sector, as they may find it more convenient and profitable to deposit their funds with the RBI rather than take credit risks. 

Conclusion

SDF is expected to enhance the effectiveness and transmission of the RBI’s monetary policy, improve the profitability and liquidity of the banks, and stimulate credit demand and investment in the economy. However, SDF may also affect the demand and supply of government securities, discourage the banks from lending to the private sector, and create a moral hazard problem for the banks. 

Therefore, the RBI has to use SDF judiciously, adjust the rates regularly, and in coordination with other tools of liquidity management to achieve its objectives of price stability and economic growth.

FAQs| SDF- Standing Deposit Facility

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

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