RBI’s cash reserve stunner was a V3R prod for banks

livemint.com:

RBI) has always maintained that it has several instruments at hand to address issues relating to monetary conditions. While market sentiment is guided largely by its policy rate actions, it has often surprised by using these tools from time to time. There was, for instance, the innovative Standing Deposit Facility (SDF) introduced to absorb overnight liquidity without involving government securities (GSecs), which made it better than its overnight reverse repo window.

More recently, RBI’s incremental cash reserve ratio (ICRR) was a master-stroke; it shocked the market and hence was potent. This was an instrument long forgotten as being part of the monetary policy toolkit, although it had resurfaced during demonetization when banks were inundated with deposits. A 100% ICRR was imposed in November 2016 and withdrawn subsequently once conditions stabilized.

Back then, the situation was quite singular, as the system was in a state of turmoil with people rushing to deposit their currency notes. However, it was not a systemic shock that led to its recent deployment. Rather, it was for its utility as a conventionally unconventional regulatory tool when ‘all else fails.’ The market was taken by surprise.

It was believed that liquidity management would be done through RBI’s variable rate repo (V2R) and variable reverse repo rate (V3R) auctions, as this was emphasized repeatedly by it as part of its efforts to guide liquidity. The V2R auctions were meant to provide liquidity and V3R to absorb it from the system through tenures that could go up to 28 days. The two tools were quite innovative, as they came as improvements over standard open market operations (OMOs).