Surplus Liquidity and Overnight Money-Market Rates

Surplus banking-system liquidity exists when banks collectively hold funds beyond their reserve, settlement and normal lending requirements. Operationally, it is reflected when the Reserve Bank of India becomes a net absorber of liquidity from the banking system through its liquidity-management facilities.

Effect on overnight rates

Overnight money-market rates are determined by the immediate demand for and supply of funds. When liquidity is abundant, fewer banks need overnight borrowing while more institutions seek to lend, causing rates such as the weighted average call rate, market repo rate and TREPS rate to decline.

• The weighted average call rate may move below the policy repo rate and towards the floor of the liquidity corridor.
• Banks may prefer parking excess funds with the RBI or lending them in collateralised overnight markets rather than competing to borrow.
• Persistent surplus liquidity can also soften other short-term money-market rates and ease broader financing conditions.

Role of the liquidity corridor

The RBI seeks to keep the operating target, the weighted average call rate, aligned with the policy repo rate. The Standing Deposit Facility, introduced in 2022, enables eligible entities to place overnight funds with the RBI without collateral and forms the floor of the liquidity corridor; the Marginal Standing Facility forms its ceiling.

• Under surplus conditions, overnight rates normally gravitate towards the corridor floor because funds can be deposited with the RBI.
• Some market rates may fall below the floor because access to RBI facilities is restricted to eligible entities and liquidity is unevenly distributed across market participants.

RBI response and qualifications

The RBI may absorb excess liquidity through the Standing Deposit Facility, variable-rate reverse repo auctions and other liquidity-management operations. Such absorption prevents overnight rates from remaining materially below the policy rate and preserves monetary-policy transmission.

• The impact depends on whether the surplus is temporary or persistent, and whether funds are evenly distributed among banks.
• Payment flows, tax collections, government cash balances, collateral availability and reporting-date pressures can temporarily alter overnight rates despite an aggregate surplus.