The Reserve Bank of India has been running large variable rate reverse repo (VRRR) auctions this week to drain excess cash from the banking system. But what is a VRRR, and why does it matter?

A reverse repo is when the RBI borrows money from banks overnight, paying them interest. The variable rate version lets banks bid for the interest rate they want, unlike the fixed-rate reverse repo. When the RBI conducts a VRRR auction, it is temporarily locking away surplus funds.

The central bank does this because too much cash in the system pushes overnight lending rates down, which weakens the transmission of its policy rates. Soaking up surplus keeps short-term borrowing costs anchored near the repo rate.

This week the RBI absorbed over Rs 2.1 lakh crore in one round of auctions and announced a Rs 3 lakh crore auction for October 7. Surplus liquidity crossed Rs 5 lakh crore in early October, driven by foreign inflows and government spending. Tightening liquidity also supports the repo rate hike to 5.50 percent announced this week.