Variable Rate Repo (VRR) Auctions

Source: BS

Context:

The Reserve Bank of India injected ₹55,837 crore into the banking system through a 3-day Variable Rate Repo (VRR) auction to ease tightening liquidity conditions.

What is Variable Rate Repo (VRR)?

A Variable Rate Repo is a monetary policy tool used by the Reserve Bank of India to inject liquidity into the banking system when there is a shortage of funds.

Unlike the fixed repo rate, the interest rate in VRR is determined through competitive bidding by banks.

How VRR Auctions Work

Announcement

The RBI announces the amount of liquidity to be injected and the duration of the repo, for example ₹1 lakh crore for 3 days.

Bidding by Banks

Commercial banks submit bids specifying:

• Amount they want to borrow
• Interest rate they are willing to pay

Allotment

The RBI accepts bids starting from the highest interest rate down to a cut-off rate.
The cut-off rate is the lowest accepted rate at which funds are allotted.

Collateral Mechanism

Banks provide government securities as collateral.
They repurchase these securities at the end of the repo period.

Objective of VRR

The main objective is liquidity management by ensuring that banks have sufficient funds.

It helps:

• Prevent spikes in short-term interest rates
• Maintain stability in the money market
• Align the call money rate with the policy repo rate

Key Features of VRR

Market-Determined Rate

Interest rate is decided through bidding, reflecting real demand and supply conditions.

Short-Term Instrument

Typically used for short durations such as 1 to 14 days.

Flexible Tool

Used to address temporary liquidity mismatches due to factors like:

• Tax outflows
• Government spending patterns
• Seasonal demand

Collateralised Lending

Loans are backed by government securities, ensuring safety.

VRR vs Fixed Rate Repo

In fixed repo, RBI lends at a predetermined rate.
In VRR, the rate is discovered through auction, making it more market-driven.