Mumbai, February 10 Banks, especially those with ample liquidity, are raising funds in the Tri-Party Repo (TREPS) market at relatively lower rates, and simultaneously deploying money with the RBI under the Standing Deposit Facility (SDF) for higher returns, effectively locking in a near risk-free spread, dealers said on Tuesday.
According to dealers, banks have found an opportunity to earn up to 0.70 per cent through arbitrage opportunities created by the gap between the Reserve Bank of India's SDF rate and the TREPS rate.
TREPS is a collateralized money market segment where banks and mutual funds lend and borrow funds, with mutual funds largely active on the lending side. Rates in the TREPS market are influenced by liquidity conditions, demand-supply dynamics, regulatory requirements, and overall market sentiment.
On the other hand, SDF rates remain fixed and only move when the central bank reduces or increases the policy repo rate.
RBI data showed that the spread between TREPS and SDF rates has steadily widened in recent days, from 0.33 per cent on January 30 to 0.43 per cent on February 2, 0.60 per cent on February 3, and peaking at 0.76 per cent on February 4.
The spread stood at 0.70 per cent on February 5, narrowed to 0.40 per cent on February 6, and again expanded to 0.63 per cent on Monday.
The widening gap between the two rates has made the strategy attractive in the short term, especially for banks with ample liquidity, market participants said.
The arbitrage opportunity emerged after liquidity in the banking system turned into a large surplus following the RBI's recent liquidity infusion measures. This surplus has pushed down overnight market rates, which are highly sensitive to liquidity conditions.
V Ramachandra Reddy, Head of Treasury at Karur Vysya Bank, told PTI that traditionally, periods of surplus liquidity have prompted the RBI to conduct VRRR operations to drain excess funds. However, the absence of such operations in the current phase is notable, allowing overnight rates to remain anchored below the SDF rate. This stance appears deliberate.
Variable Rate Reverse Repo (VRRR) operations are monetary policy tools used by the RBI to temporarily absorb excess liquidity from the banking system.
"Given the elevated term premia in the 3-12 month money market segment, the RBI may be attempting to compress these spreads by keeping overnight liquidity abundant and rates soft. Lower TREPS rates incentivize banks to meet short-term funding requirements at a reduced cost, helping contain the overall cost of funds amid tight deposit conditions."
However, banks have been parking more funds with the RBI under the SDF instead of participating in the call money market, which drew the attention of the RBI for a few months.
The RBI has been pushing banks to increase participation in the call money market to deepen liquidity and improve price discovery, though lenders continue to prefer the SDF route, money market experts said.
A similar instance was seen last year in May, when banks were using this opportunity to earn arbitrage from both these instruments.