Surplus liquidity in banking system

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As per the Reserve Bank of India (RBI’s) data release, Surplus liquidity in the banking system has declined 42.9 per cent due to advance tax payments.
About the information:
  • The surplus liquidity is reflected by the amount of money absorbed by the Reserve Bank of India (RBI) which was fallen after the deadline for advance tax payout.
  • Liquidity in the banking system is the difference between incremental credit and deposits.
  • The current fall in (surplus) liquidity is a case of deposits coming down because of advance tax payments.
What is Surplus liquidity?
  • Liquidity in the banking system refers to readily available cash that banks need to meet short-term business and financial needs.
  • On a given day, if the banking system is a net borrower from the RBI under Liquidity Adjustment Facility (LAF), the system liquidity can be said to be in’ deficit’ and if the banking system is a net lender to the RBI, the system liquidity can be said to be in ‘surplus’.
The LAF refers to the RBI’s operations through which it injects or absorbs liquidity into or from the banking system.
  • Sources: 
    • Essentially, liquidity surplus is because of the deposits which have started increasing due to rise in interest rates.
Why do Banks see surplus liquidity ‘beneficial’?
  • Commercial banks have current accounts with central banks.
  • All (excess) liquidity is held either in these central bank current accounts or in the deposit facility.
  • In other words, excess liquidity by definition stays with the central bank.
  • An individual bank can reduce its excess liquidity, for example by lending to other banks, purchasing assets or transferring funds on behalf of its clients.
Consequences of excess liquidity:
  • As a consequence of excess liquidity, market interest rates will remain low. 
  • This means it is cheaper for companies and people to borrow money, thus helping the economy recover from the financial and economic crisis, and allowing the banking system to build up liquidity buffers.
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