Sterilized Reverse Repo, also known as a sterilized operation, is a mandatory policy tool used by central banks to manage liquidity in the financial system. It involves the sale of government securities by the central bank to commercial banks or other financial institutions with an agreement to repurchase them at a future date.
Here is how sterilized reverse repo works:
1.
Sale
of Securities: The central
bank initiates a sterilized reverse repo operation by selling government
securities, such as Treasury bonds or bills, to commercial banks or other
eligible counterparties in the open market. These transactions take place
through a reverse repurchase agreement (reverse repo), where the central bank
acts as the seller and the counterparty buyer.
2.
Cash
Inflow and Liquidity Absorption:
Through the reverse repo transaction, cash flows from the commercial banks to
the central bank, resulting in a temporary reduction in the liquidity available
in the banking system. The cash received by the central bank reduces the excess
reserves held by commercial banks, absorbing liquidity from the market.
3.
Agreement
to Repurchase: At a time, the
reverse repo transactions, the central bank and the counterparty agree on a
future repurchase date and price. This repurchases agreement ensures that the central
bank will buy back the government securities from the counterparty on a specified
date, usually at a slightly higher price, effectively reversing the initial
transaction.
4.
Interest
Rate and Liquidity Management:
Sterilized reverse repo operations are primarily used by central banks to
manage short-term interest rates and control the level of liquidity in the
financial system. By absorbing excess liquidity through the sale of government
securities, the central bank can increase short-term interest rates and
encourage commercial banks to invest their funds in the reverse repo, which
offers a safe and interest earning alternative.
5. Sterilized of Open Market Operations: The term Sterilized is sterilized reverse repo refers to the central bank’s intention of offset the impact of its open market operations on the money supply. When the central bank purchase government securities in open market operations, it injects liquidity into the market. Sterilized reverse repo operations serve as a tool to withdraw that liquidity and prevent any inflammatory pressure resulting from the initial purchase.
Sterilized reverse repo operations play a
significant role in the implementation of monetary policy and the management of
liquidity by central banks. They help regulate short-term interest rates,
control money supply, and maintain financial stability in the economy.