RBI Liquidity Management Framework Review
The Reserve Bank of India (RBI) in 2025 released a key report from the Internal Working Group (IWG) reviewing the liquidity management framework. This report addresses challenges in managing liquidity which is central to effective monetary policy. The RBI aims to improve operations to ensure smoother control over short-term interest rates and better market stability.
Discontinuation of 14-Day Variable Rate Repo
The IWG recommends stopping the 14-day variable rate repo/reverse repo as the main liquidity operation. Banks hesitate to lock surplus funds for 14 days. Also, forecasting liquidity needs for this duration is difficult due to volatile government cash balances and unpredictable currency flows. Weekly main operations combined with flexible fine-tuning tools are suggested for better liquidity smoothing.
Weighted Average Call Rate as Operating Target
The report supports retaining the weighted average call rate (WACR) as the operating target. However, activity in the overnight call money market, where WACR is formed, has declined. This weakens RBI’s control over short-term rates. The narrowing of the interest rate corridor has reduced market activity, as banks prefer dealing with RBI rather than inter-bank transactions. A balance between corridor width and market vibrancy is essential.
Role of Reserve Requirements and Averaging
Minimum reserve requirements and averaging mechanisms help stabilise call money rates by smoothing shocks from government cash and currency fluctuations. Banks can time their borrowings within the maintenance period to manage costs. Yet, this system is underused as banks maintain higher daily reserve balances than required. Lowering daily minimum reserves could enhance arbitrage opportunities and reduce rate volatility.
Standalone Primary Dealers and Market Volatility
Standalone primary dealers (SPDs) contribute to call money market volatility. They borrow heavily but lack access to the marginal standing facility (MSF), causing rates to breach corridor limits during tight liquidity. The IWG rejects MSF access for SPDs but suggests phasing out their call money market participation. Alternative borrowing and lending options should support their role in government securities markets.
Challenges of Structural Surplus Liquidity
Large structural liquidity surplus complicates aligning the operating target with the policy rate. The WACR often deviates from the policy rate and breaches corridor bounds, creating market uncertainty. Effective liquidity management must ensure the operating target stays close to the policy rate to facilitate smooth monetary transmission across interest rates and asset classes.
Need for a Balanced Corridor Width
The 50 basis points corridor width is narrow compared to other emerging economies. While it reduces interest rate volatility, it suppresses inter-bank market activity. The IWG report calls for detailed empirical study to evaluate corridor width trade-offs. Adjusting the corridor may improve market functioning and RBI’s control over short-term rates.
| Related | |
|---|---|
