Sensing a critical need to make its monetary policy effective, the Reserve Bank of India (RBI) has presented a detailed report of an Internal Working Group (IWG), which suggests a sweeping revision of the current liquidity management mechanism. The recommendations are intended to deal with ongoing problems related to managing the short-term interest rates, and providing more stability on the financial markets. This review is taking place at a time when turbulent government cash balances and an uncertain foreign currency forecast have challenged RBI to control systemic liquidity that is vital in relaying policy rate transitions to the rest of the economy.
Material Recommendations of the Internal Working Group
1. Phase-Out of 14-Day VRRR as a Primary Tool
One of the main areas to stop is use of 14- day Variable Rate Reverse Repo (VRRR) as the main liquidity operation. The IWG observed that due to uncertainty, banks may be unwilling to tie up their excess funds during a two week time. The report recommends greater usage of week by week activities with supplementary polynomial flexibility tools to are more adaptable in terms of liquidity control.
2. Restating WACR as the Operating Target but with Caveats
The group advocates maintenance of the Weighted Average Call Rate (WACR)- the interest rate at which banks borrow and lend overnight funds- as the operating target of the monetary policy. It however raised a worrying dip in activity of the call money market. The decrease in the policy corridor (reckoned as the difference between the repo and the reverse repo rate) to 50 basis points has intuitively weakened the motivation to inter-bank lending as the banks would now find it convenient to lodge funds at the RBI. According to the report, balance needs to be maintained between a narrow corridor in favour of stability and a broader corridor that fosters active market activity.
3. Optimizing Reserve requirements
The averaging clause on banks Cash Reserve Ratio (CRR) enables them to carry the reserves on the daily basis as far as the average over a fortnight takes care of the requirement. This tool assists in ironing out day-to-day liquidity shocks The IWG observed however that banks tend to hold excessive balances in excess of the minimum daily balances and therefore the effectiveness of the tool is nullified. It proposed that reducing these daily minimums would improve the arbitrage opportunities, and help stem the volatility in call rates.
4. Amending Standalone primary dealers (SPDs) volatility
The report revealed an issue with Standalone Primary Dealers (SPDs) as being a source of volatility in the overnight market. Unlike banks, SPDs also borrow on a large scale and will not have access to Marginal Standing Facility (MSF); a safety net available to banks that may lead to soaring call rates above the upper corridor figure in periods of liquidity crunch. Although the IWG did not agree to allow MSF access to SPDs, it recommended the phasing out of MSF in the call money market as well as coming up with alternative means through which funds can be raised to finance them.
5. Addressing structural liquidity surplus
A consistent challenge has been the high amount of structural surplus liquidity in the system which has in many cases made the WACR diverge widely with the policy repo rate and also surpasses the corridor limits. This brings about uncertainty and prevents the monetary policy transmission process. The amended framework is expected to keep the operating target in line with the policy rate to provide a smoother cross of all rates of interest and all assets.
Implications to the Financial System
The proposed alternation will constitute one of the possible paradigm shifts in the way the RBI regulates the liquidity. In shifting to a shorter-term and
Month: Current Affairs - August 25, 2025
Category: current affairs daily