Standing Deposit Facility (SDF) – Simplified Explanation
What is SDF?
Standing Deposit Facility (SDF) is a tool used by the Reserve Bank of India (RBI) to absorb excess money from banks without giving them collateral (security).
Why is SDF needed?
Banks often have extra money that they deposit with RBI to earn some interest. Earlier, the RBI used Reverse Repo Rate for this, where it would take money from banks and give government securities as collateral. But sometimes, RBI may not have enough securities to offer.
To solve this issue, SDF allows banks to deposit money with RBI without needing any security.
Example to Understand SDF Easily
Imagine you have a piggy bank where you store extra money. Now, instead of keeping it at home, a bank offers you a safe deposit facility where they will hold your money safely and even pay you some interest—but they won’t give you anything in return, like gold or property, as a guarantee.
This is exactly what happens in SDF. Banks deposit their extra money with the RBI and earn interest, but they don’t get any collateral in return.
Little Confuse?? Don't worry! I'll explain Standing Deposit Facility (SDF) in the easiest way possible with a step-by-step approach, real-life examples, and numbers.
Step 1: Why was SDF introduced?
Before understanding SDF, let's first recall how banks deposit extra money with the RBI.
- Banks often have extra money (excess liquidity), which they want to deposit safely and earn interest.
- Earlier, they used Reverse Repo Rate for this.
- But under Reverse Repo, RBI had to give government securities (bonds) as collateral in exchange for the deposits.
- The problem? RBI sometimes doesn’t have enough government securities to provide.
So, in 2022, RBI introduced SDF, where banks can deposit extra money with RBI without needing any security (collateral).
Step 2: How does SDF work?
🔹 Reverse Repo vs. SDF
| Feature | Reverse Repo | SDF |
|---|---|---|
| Collateral Given by RBI? | ✅ Yes (Government Bonds) | ❌ No (No Collateral) |
| Interest Earned by Banks? | ✅ Yes | ✅ Yes |
| Purpose? | Absorb excess liquidity | Absorb excess liquidity |
- SDF is a new tool that works like Reverse Repo but without collateral.
Step 3: Example with Numbers
🔹 Situation: Imagine Bank XYZ has ₹500 crore extra money that it wants to deposit with RBI.
🔹 Old method (Reverse Repo Rate):
- Bank XYZ deposits ₹500 crore with RBI.
- RBI gives government securities as collateral in exchange.
- Bank XYZ earns interest at the Reverse Repo Rate (say 3.35%).
🔹 New method (SDF):
- Now, Bank XYZ directly deposits ₹500 crore with RBI under SDF.
- RBI does NOT give any collateral in return.
- Bank XYZ still earns interest (SDF rate, which is slightly lower than the repo rate, say 3.25%).
Step 4: Why is SDF important?
✔ No need for collateral: Banks can park extra money with RBI easily.
✔ Helps control inflation: RBI absorbs excess liquidity to reduce inflation.
✔ Better liquidity management: RBI can regulate money supply efficiently.
✔ Reduces dependence on Reverse Repo: RBI doesn’t have to provide collateral every time.
Super Simple Real-Life Analogy
Imagine you own a shop and have extra ₹5,000 at the end of the day. You have two options:
- Old method (Reverse Repo): You give ₹5,000 to your friend (RBI) and he keeps your gold chain as security in return. After a few days, you get ₹5,000 + interest back and return the gold chain.
- New method (SDF): You simply give ₹5,000 to your friend (RBI) without asking for any security and still earn interest on it!
SDF is like giving money to a trusted friend without asking for a guarantee but still getting rewarded for it.
Final Understanding
✔ SDF allows banks to deposit excess money with RBI without collateral.
✔ It helps RBI absorb extra liquidity to control inflation.
✔ It works like Reverse Repo but is more flexible and efficient.
Key Points About SDF
- Introduced in 2022 – First proposed in 2018 but implemented in April 2022.
- No Collateral Needed – Unlike Reverse Repo, where RBI gives securities, here banks just deposit their money.
- Helps Control Inflation – By taking out extra money from the system, RBI can reduce inflation.
- Complementary to Reverse Repo – It doesn’t replace Reverse Repo but works alongside it.
Prelims (MCQ) Question:
Q. Consider the following statements regarding the Standing Deposit Facility (SDF):
- SDF is a liquidity absorption tool introduced by the Reserve Bank of India (RBI).
- Under SDF, banks deposit their excess funds with RBI and receive collateral in return.
- SDF helps in controlling inflation by absorbing excess liquidity from the banking system.
Which of the above statements are correct?
(A) 1 and 2 only
(B) 2 and 3 only
(C) 1 and 3 only
(D) 1, 2, and 3
➡ Answer: (C) 1 and 3 only
(Statement 2 is incorrect because SDF does not provide any collateral.)
Mains (Descriptive) Question:
Q. What is the Standing Deposit Facility (SDF)? How does it help the RBI in managing liquidity and controlling inflation? Discuss its significance in India's monetary policy. (10 marks, 150 words)
Example of a Related UPSC Prelims Question:
If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do?
- Cut and optimize the Statutory Liquidity Ratio
- Increase the Marginal Standing Facility Rate
- Cut the Bank Rate and Repo Rate
Select the correct answer using the code given below:
(A) 1 and 2 only
(B) 2 only
(C) 1 and 3 only
(D) 1, 2, and 3
Answer: (B) 2 only
Explanation: An expansionist monetary policy aims to increase money supply to stimulate economic growth. Cutting the Statutory Liquidity Ratio (SLR) (Statement 1) and reducing the Bank Rate and Repo Rate (Statement 3) are measures to increase liquidity. However, increasing the Marginal Standing Facility (MSF) Rate (Statement 2) would make borrowing more expensive, which is contractionary.
Example of a Related UPSC Mains Question:
What are the instruments of monetary policy used by the Reserve Bank of India to control liquidity in the economy? Discuss the effectiveness of these instruments in the current economic scenario.
Note: While direct questions on SDF may not have appeared in past UPSC exams, its relevance in monetary policy makes it a potential topic for future questions. A thorough understanding of SDF and its role in liquidity management is essential for comprehensive exam preparation.