One-day Variable Rate Reverse Repo (VRRR)

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Context

• The Reserve Bank of India (RBI) conducted two one-day variable rate reverse repo (VRRR) auctions to drain out liquidity from the banking system and re-anchor overnight money market rates at a higher level.

One-day Variable Rate Reverse Repo (VRRR)

• The one-day Variable Rate Reverse Repo (VRRR) auctions are a monetary policy tool utilized by central banks, including the Reserve Bank of India (RBI), to manage liquidity in the financial system.
• This mechanism plays a vital role in influencing short-term interest rates and controlling inflationary pressures.

Understanding VRRR Auctions:

• Reverse Repo Operations: In a VRRR auction, the central bank conducts reverse repo operations, wherein it borrows funds from commercial banks and financial institutions for a short duration, typically one day.
• Variable Interest Rates: Unlike traditional reverse repo operations with fixed interest rates, VRRR auctions involve variable interest rates. The central bank determines the interest rate based on prevailing market conditions, liquidity requirements, and monetary policy objectives.
• Short-Term Liquidity Management: VRRR auctions serve as a tool for short-term liquidity management. By conducting these auctions, the central bank can absorb excess liquidity from the banking system, thereby influencing short-term interest rates and ensuring price stability.

Process of VRRR Auctions:

• Announcement: The central bank announces the schedule and terms of the VRRR auction, including the date, time, and indicative size.
• Submission of Bids: Commercial banks and financial institutions submit bids specifying the amount they are willing to lend to the central bank and the interest rate they expect to receive.
• Auction Conduct: The central bank reviews the bids and determines the cutoff interest rate based on market demand and prevailing liquidity conditions.
• Acceptance of Bids: Bids submitted at or below the cutoff interest rate are accepted, and funds are borrowed from successful bidders for the specified duration.
• Execution: The central bank borrows funds from participating institutions at the determined interest rate, injecting liquidity into the banking system.

Objectives of VR Auctions:

• Liquidity Management: VRRR auctions help the central bank manage short-term liquidity fluctuations in the financial system, ensuring stability and efficiency.
• Interest Rate Control: By adjusting the interest rate in VRRR auctions, the central bank can influence short-term interest rates, aligning them with its monetary policy goals.
• Inflation Control: Effective liquidity management through VRRR auctions contributes to controlling inflationary pressures by influencing overall monetary conditions in the economy.

Conclusion:

• In summary, one-day Variable Rate Reverse Repo (VRRR) auctions are a crucial monetary policy tool employed by central banks to manage short-term liquidity and interest rates in the financial system. By conducting these auctions, central banks can effectively achieve their monetary policy objectives, ensuring price stability and sustainable economic growth.

PRACTICE QUESTION Q. What is the key purpose of one-day Variable Rate Reverse Repo (VRRR) auctions conducted by central banks such as the Reserve Bank of India (RBI)? A) To boost long-term investments in the stock market. B) To stabilize currency values in the foreign exchange market. C) To manage short-term liquidity in the financial system and regulate short-term interest rates. D) To facilitate government borrowing for infrastructure projects. Answer. C) Explanation: The primary objective of one-day Variable Rate Reverse Repo (VRRR) auctions is to manage short-term liquidity in the financial system and regulate short-term interest rates. Therefore, option C is the correct answer. Options A, B, and D do not accurately represent the primary purpose of VRRR auctions.