Why in news?
The Reserve Bank of India (RBI) conducted large variable rate reverse repo (VRRR) auctions in 2025 to absorb excess liquidity from the banking system. Understanding VRRR operations helps explain how central banks manage short‑term interest rates.
What is a reverse repo?
- A reverse repo is an instrument by which the RBI borrows money from commercial banks for a short period, giving them government securities as collateral. The banks earn interest (the reverse repo rate), while the RBI temporarily drains liquidity.
Fixed versus variable rate
- In a fixed rate reverse repo, the RBI announces a single interest rate and accepts funds at that rate until it reaches the desired amount. Banks bid only for quantity.
- In a variable rate reverse repo, the RBI conducts an auction where banks submit bids specifying both amount and interest rate. The RBI accepts bids starting from the highest offered rate until the desired volume is achieved. The cut‑off rate is generally below the policy repo rate.
Why use VRRR?
- Excess liquidity arises when government spending or foreign exchange operations inject more money than the economy needs. Too much liquidity can drive short‑term interest rates below the policy rate, undermining monetary transmission.
- VRRR auctions absorb surplus funds in a market‑determined manner, allowing the RBI to manage liquidity without constantly adjusting the policy rate.
- The auctions also provide signals about the banking system’s liquidity preferences and help calibrate future operations.
Impact
- Money markets: VRRR operations typically push overnight money market rates closer to the repo rate, maintaining the interest‑rate corridor.
- Banks: Lenders with surplus funds earn interest by parking funds with the RBI. However, repeated VRRRs may encourage banks to allocate more funds to government securities rather than commercial lending.
- Bond markets: If the RBI absorbs large amounts of liquidity, bond yields may rise as the supply of investible funds decreases.