Term Reverse Repo

Term reverse repo is an important monetary policy and liquidity absorption instrument used by the central bank to manage excess liquidity in the banking system. In India, term reverse repo operations form a crucial component of liquidity management and interest rate stabilisation, particularly during periods of surplus liquidity. Their relevance has grown alongside structural changes in the Indian financial system, expanding banking balance sheets, and increased capital flows.
Unlike overnight reverse repo operations, term reverse repos absorb liquidity from banks for a fixed period, providing greater certainty to both the central bank and financial institutions regarding the duration and cost of liquidity absorption. This mechanism plays a significant role in strengthening monetary policy transmission and maintaining orderly money market conditions.

Concept and Meaning of Term Reverse Repo

A term reverse repo is a repurchase agreement in which banks lend funds to the central bank for a specified tenor in exchange for eligible securities, usually government securities. The central bank commits to repurchase these securities at a predetermined date and interest rate, known as the reverse repo rate.
The distinguishing feature of term reverse repos is their longer maturity compared to overnight reverse repos. Tenors typically range from seven to fourteen days, though longer durations may be used depending on prevailing liquidity conditions. By locking in surplus funds for a defined period, term reverse repos help absorb durable liquidity from the system.

Evolution of Term Reverse Repo in India

The introduction of term reverse repo operations in India was driven by the need to manage persistent surplus liquidity more effectively. Traditionally, the liquidity adjustment framework relied heavily on overnight reverse repo operations. However, sustained excess liquidity led to distortions in money market rates and weakened monetary policy transmission.
To address these challenges, the Reserve Bank of India expanded the use of term reverse repo auctions. This shift allowed the central bank to absorb liquidity on a more enduring basis and reduce volatility in short-term interest rates. Term reverse repos thus complemented term repo operations, creating a more balanced liquidity management framework.

Objectives of Term Reverse Repo Operations

The primary objective of term reverse repos is to absorb excess liquidity from the banking system in a predictable and non-disruptive manner. By providing banks with an assured return for parking surplus funds over a fixed period, the central bank discourages excessive short-term liquidity chasing and speculative behaviour in money markets.
Another key objective is to reinforce the policy interest rate corridor. Term reverse repos help prevent short-term market rates from falling significantly below the policy rate during periods of surplus liquidity, thereby preserving the effectiveness of monetary policy signals.

Role in Banking Liquidity Management

For banks, term reverse repos provide a safe and risk-free avenue to deploy surplus funds. They offer better returns than overnight facilities while ensuring high liquidity and minimal credit risk. This is particularly useful when credit demand is weak or when banks face uncertainty in lending opportunities.
By absorbing funds for longer tenors, term reverse repos encourage banks to plan liquidity more efficiently and reduce frequent reliance on overnight parking facilities. This contributes to improved asset-liability management and overall financial discipline within the banking system.

Impact on Money Markets

Term reverse repo operations have a stabilising influence on money markets by moderating excess liquidity and anchoring short-term interest rates. By withdrawing surplus funds, they reduce downward pressure on call money rates and other short-term instruments.
Stable money market conditions enhance investor confidence and support the smooth functioning of financial markets. They also facilitate efficient pricing of money market instruments such as treasury bills, certificates of deposit, and commercial paper.

Significance for Monetary Policy Transmission

Effective monetary policy transmission requires that market interest rates remain aligned with the central bank’s policy stance. During periods of abundant liquidity, this alignment can weaken as surplus funds drive rates below the policy corridor.
Term reverse repos strengthen transmission by absorbing liquidity over a longer horizon and preventing excessive divergence of market rates. This ensures that changes in the policy rate are reflected more accurately in banks’ deposit and lending rates, influencing consumption, investment, and inflation dynamics.

Relevance to the Indian Economy

At the macroeconomic level, term reverse repos contribute to financial stability by preventing liquidity-driven imbalances. They help maintain orderly conditions in the banking system, which is vital for sustained credit flow and economic growth in India.
By supporting stable interest rates, term reverse repos also aid government borrowing programmes and reduce volatility in the government securities market. This indirectly supports fiscal management and long-term economic planning.
In an economy characterised by periodic liquidity surpluses arising from capital inflows, government spending, or accommodative monetary policy, term reverse repos serve as an essential counterbalancing instrument.