VARIABLE REPO RATE (VRR)

• The Variable Repo Rate (VRR) is a type of liquidity adjustment tool used by the Reserve Bank of India (RBI), where banks can borrow funds for the short term at market-determined interest rates through an auction mechanism. 
• Unlike the fixed repo rate operations, where the borrowing rate is pre-determined by the RBI, the VRR allows market forces to decide the borrowing cost.

How Does VRR Work?

• Under VRR, the RBI conducts auctions (usually of 1-day to 14-day maturity).
• Banks bid for the amount they want to borrow and specify the rate at which they are willing to borrow.
• Based on the bids received, RBI accepts the most favourable ones.
• The rate determined through this competitive bidding becomes the variable repo rate.
• However, this rate cannot be lower than the Reverse Repo Rate, ensuring a floor to prevent arbitrage.

Why is VRR Needed?

• In certain market situations, particularly when short-term interest rates fall below the fixed repo rate, banks hesitate to borrow using the regular repo window. 
• To align with market realities, RBI introduces VRR to inject liquidity at market-compatible rates.
• This makes liquidity support more attractive to banks without distorting the policy stance set by the Monetary Policy Committee (MPC).

VRR vs. Fixed Rate Repo

VRR as a Tool of Liquidity Management

• The VRR is an important part of RBI’s Liquidity Adjustment Facility (LAF). It helps in:
• Providing short-term liquidity to banks.
• Maintaining financial stability.
• Aligning market rates closer to the policy repo rate.
• Enhancing transmission of monetary policy.

Relation with Variable Rate Reverse Repo (VRRR)

• Along with VRR, the RBI also uses the Variable Rate Reverse Repo (VRRR) to absorb excess liquidity from the banking system.
• In VRRR, banks deposit surplus funds with RBI through auctions.
• The interest rate is again determined by competitive bidding, usually close to or above the reverse repo rate.
• VRRR becomes vital when the system is flush with liquidity, helping control inflationary pressures.

Key Features of VRR:

• Flexible Tenure: 1-day to 14-days or even longer, depending on market needs.
• Auction-based: Encourages competition and transparency.
• Effective Tool: Balances short-term liquidity needs and monetary stability.
• Linked to LAF Corridor: Ensures rates remain within the repo-reverse repo band.