Source: ET
Context: The Reserve Bank of India (RBI) conducted a ₹1 lakh crore 7-day Variable Rate Reverse Repo (VRRR) auction to manage surplus liquidity, which had peaked at ₹3.75 lakh crore.
About Variable Rate Reverse Repo (VRRR):
- What is VRRR?
- The Variable Rate Reverse Repo (VRRR) is a monetary policy tool used by the RBI to absorb excess liquidity from the banking system for a fixed duration, with the interest rate determined through auction rather than being fixed.
- It allows banks to lend funds to the RBI for a period longer than one day — typically 7, 14, or 28 days — in exchange for interest.
- Announced By: The Reserve Bank of India (RBI) as part of its liquidity management framework.
- Objective:
- To manage surplus liquidity in the financial system.
- To fine-tune short-term interest rates and strengthen the monetary transmission mechanism.
- To provide a market-driven interest rate environment in short-term lending between banks and the central bank.
- How It Works?
- The RBI announces a VRRR auction specifying the total amount and tenor (e.g., 7 days).
- Banks submit competitive bids indicating the amount and rate at which they are willing to lend funds to RBI.
- RBI selects the cut-off rate based on bids received and accepts offers at or above that rate.
- Banks earn interest based on the market-determined rate during the period of the VRRR.
- Key Features:
- Market-determined rates: Interest rates are discovered via auction, not fixed by RBI.
- Term-based: Unlike the overnight fixed reverse repo, VRRR operates for multiple days, often 7 or 14.
- Liquidity absorption tool: Used when there is excess liquidity in the banking system.
- Upper rate limit: VRRR rate cannot exceed the prevailing Repo Rate.
- Flexibility: RBI can conduct VRRR of varying durations depending on liquidity conditions.
- Implications of VRRR:
- Money Market Impact: Leads to tighter liquidity, pushing up short-term rates like the call money and TREPS (tri-party repo) rates.
- Bond Market Impact: An increase in VRRR rates may raise short-term bond yields, making borrowing costlier for the government and corporates.
- Banking Sector Impact:
- Offers banks a higher return on surplus funds, enhancing profitability.
- However, it temporarily locks funds, potentially limiting their availability for lending and investment.
