RBI Should Allow Early Exit to Make Its Term VRRR Auctions Effective

The Reserve Bank of India should make premature withdrawal a standard feature of seven-day and fortnightly variable rate reverse repo auctions, subject to simple, pre-announced conditions. The facility would address the main reason bank treasuries hold back from longer-tenor VRRRs: the risk that funds needed unexpectedly could remain locked away.

Since August 6, the RBI has notified ₹20 trillion across six term auctions but accepted only ₹6.66 trillion, or 33.3%. Take-up in the latest seven-day auction was just 19.05%, while the 15-day operation conducted a day earlier achieved 22.44%. By contrast, the four-day auction on August 6 achieved 86.86%.

The comparison is not exact because liquidity conditions and banks’ positions change from one auction to another. But the pattern is consistent with banks becoming increasingly reluctant to surrender flexibility as the tenor lengthens.

System liquidity can be abundant while an individual bank remains uncertain about its own closing position. Deposit movements, government flows, securities settlement, cash withdrawals and 24X7 payment activity can alter balances quickly. A treasury therefore values optionality. Parking funds overnight is manageable; committing a large amount for a week or a fortnight can appear imprudent even when the banking system as a whole is awash with cash.

That reluctance has probably risen after the special FCNR(B) mobilisation. The scheme brought in $127 billion by end-August, while related schemes could take total inflows above $140 billion. Daily liquidity adjustment facility surplus had already reached ₹9.7 trillion, and the system surplus could peak above ₹10 trillion.

The RBI’s revised framework makes the seven-day VRR or VRRR its primary instrument for managing transient liquidity. Yet overnight rates have remained below the repo rate and have gravitated towards, or below, the standing deposit facility rate. Weak participation in term VRRRs is therefore impairing the RBI’s ability to align overnight money-market rates with its operating target.

 

Usable Precedent
In its 90-day VRR auction in January, the RBI allowed banks to prepay borrowings before maturity. Requests could be submitted through e-Kuber at least two days before reversal; partial prepayment was barred, and settlement occurred on the next working day. A similar architecture can be adapted to the absorption side.

Banks could be allowed to seek early release at any point after allotment, with settlement on the next working day. Interest could be paid only until the exit date, perhaps at the lower of the auction rate and the SDF rate. A modest exit charge could discourage routine use. The process should be automatic rather than discretionary because certainty about access is what would make the option effective.

The RBI may worry that premature withdrawal would reduce its control over liquidity absorption. That objection has force for three- or six-month sterilisation, where visibility over the amount and duration of absorption is essential. It is less persuasive for seven-day and fortnightly fine-tuning operations.

The practical choice is between firm absorption that attracts few bids and conditionally reversible absorption that attracts substantially more. Actual withdrawals may remain limited precisely because having the option would reduce banks’ perceived need to retain precautionary liquidity.

The RBI should pilot the facility over a series of auctions and disclose the amounts withdrawn prematurely. If participation rises materially while actual exits remain small, the option should become a standing feature. Before turning to blunter liquidity-absorption measures, the central bank should improve the design of the instrument it already wants banks to use. End

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