RBI announces steps to ease pressure on liquidity

#GS3 #Economy


Recently, the Reserve Bank of India (RBI) announced a host of steps, including term repo operations totaling Rs. 1 lakh crore in mid-September to ease pressure on the liquidity and maintain congenial financial conditions with a view to ensuring sustainable recovery of economic growth.

Highlights of the announcement by RBI

  • The Central Bank stated that it stands ready to conduct market operations as required through a variety of instruments so as to ensure orderly market functioning. 
  • It mentioned that recent market sentiment has been impacted by concerns relating to the inflation outlook and the fiscal situation amidst global developments that have firmed up yields abroad.
  • As part of the measures to ‘foster orderly market conditions’, the RBI will conduct term repo operations for an aggregate amount of Rs 1,00,000 crore at floating rates (at the prevailing repo rate) in the middle of September to assuage pressures on the market on account of advance tax outflows.
  •  In order to reduce the cost of funds, banks that had availed of funds under long-term repo operations (LTROs) may exercise the option of reversing these transactions before maturity.
  • RBI will conduct additional special open market operations involving the simultaneous purchase and sale of government securities for an aggregate amount of Rs 20,000 crore in two tranches of Rs 10,000 crore each. The auctions would be conducted on September 10, 2020, and September 17, 2020.

Repo and Reverse Repo Rate

  • Repo Rate: It is the rate at which the central bank of a country i.e. RBI, lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation. It is the rate at which RBI lends money to commercial banks against Government Securities (G-Sec). 
  • Reverse repo rate: It is the rate at which the central bank of a country i.e. RBI, borrows money from commercial banks within the country. It is a monetary policy instrument that can be used to control the money supply in the country.

Long Term Reverse Repo Operation (LTRO)

  • Long Term Reverse Repo Operation (LTRO) is a mechanism to facilitate the transmission of monetary policy actions and the flow of credit to the economy. This helps in injecting liquidity in the banking system.
  • Funds through LTRO are provided at the repo rate. This means that banks can avail one year and three-year loans at the same interest rate of one day repo. But usually, loans with higher maturity period (here like 1 year and 3 years) will have a higher interest rate compared to short term (repo) loans.
  • According to the RBI, the LTRO scheme will be in addition to the existing Liquidity Adjustment Facility (LAF) and the Marginal Standing Facility (MSF) operations.

Potential effects of the LTRO

  • This will enhance liquidity in the banking system.
  • Since the interest rate is comparatively low, there will be downward pressure on short term lending rates.
  • It will result in a slightly easy Monetary Policy.
  • This will help banks to get funds for a longer duration as compared to the short-term liquidity.
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