Surplus liquidity in the banking system poses challenges as much as deficit liquidity. Examine with reference to RBI's recent liquidity absorption measures.

Liquidity management under the RBI's Liquidity Adjustment Facility (LAF) aims to keep the overnight call rate anchored to the policy repo rate [2]. While deficits are the more visible threat, the September 2026 auctions — in which the RBI absorbed over ₹6 lakh crore in a single day — show that excess funds strain the system just as much [3].

Deficit liquidity: the familiar constraint

• Raises the weighted average call rate (WACR) above the repo rate, tightening credit beyond what the MPC intended.
• Forces banks into MSF borrowing, raising funding costs and squeezing lending to productive sectors.
• RBI responds through repo operations and OMO purchases.

Why surplus liquidity is equally challenging

• Weakens transmission downward: call rates drift toward the floor of the corridor, de-linking market rates from the policy signal.
• Inflationary risk: idle funds chase assets, fuelling credit and asset-price build-up.
• Erodes bank margins as banks park funds at reverse repo rates below lending yields.
• Encourages lax credit appraisal, a stability concern flagged in RBI's supervisory framework.

RBI's recent absorption measures

• Use of Variable Rate Reverse Repo (VRRR) auctions, where the rate is market-discovered through bidding rather than fixed — the RBI notified ₹7 lakh crore under the LAF in early September 2026 [1].
• Calibration by tenure: a tepid response to the term auction prompted a same-day overnight VRRR, which drew ₹3,53,390 crore, about 70% of the notified amount, accepted at a cut-off of 5.24% [3].
• Complementary durable tools — OMO sales and CRR changes — for structural, not frictional, surplus.

Thus, liquidity management is a two-sided balancing act, not a one-way defence against scarcity. The episode's lesson is that banks prefer flexibility over locking funds, so absorption must be tenure-sensitive and frequent rather than large and rigid. Refining the LAF corridor with timely, market-discovered instruments will keep transmission credible and support the RBI's dual mandate of price stability and growth.