RBI's new norms can bring more efficiency in a bank's liquidity management

Doing away with assured liquidity for the banking system, as proposed by an internal group of the Reserve Bank of India (RBI), can bring more efficiency in a bank’s liquidity management.

In the current framework, the RBI assures liquidity of up to 1 per cent of the deposit base — 0.25 per cent for individual banks and 0.75 per cent for the overall system.

Now the framework is proposing that system liquidity should ideally be kept in deficit mode of 0.25-0.50 per cent of the deposit base.
 

It is important to mention here is that banking system liquidity is highly asymmetric in India. A few large banks, such as State Bank of India (SBI), are net sellers of liquidity in the market. Smaller, private-sector banks are net buyers. Now these smaller banks had the option to borrow from the RBI up to 0.25 per cent of their deposit base. 

Now, there won’t be any such option. However, now that the RBI will keep liquidity in a slight deficit mode with an objective of keeping the call money rate closer to the repo rate, banks demanding more in interest rates can be replaced by the RBI in the market, theoretically. But the lack of assurance on liquidity would force the banks to manage their liquidity profile better, say experts. 

According to the framework, if there is a build-up of a large deficit or surplus, it should be offset through durable operations. “Large” in this context is a deficit of 0.25-0.50 per cent of the deposit base. 

Such durable instruments could be open market operations (OMO), in which the central bank buys or sells bonds, foreign currency swaps, or long-term repos (lending money to banks) and reverse repo operations (taking money from banks), up to one year, at market determined interest rates. Such repo tools of up to 14 days are regularly used by the RBI, but the group wants to make it as a formal instrument for liquidity management. The maximum reverse repo term that the central bank had done was of 56 days during demonetisation.

This, according to the internal group, would be used as to manage durable liquidity needs for a few months. When the central bank buys secondary market bonds under OMO, the durable liquidity injection is permanent, which may disrupt other money market instruments.

But the focus on minimizing usage of OMO, or the lack of a liquidity stance for the future, has disappointed the bond market a little bit. The yields on the 10-year bond rose about three basis points to close at 6.74 per cent in response. 

“Liquidity management framework is more of a regime and guiding principles, and day to day liquidity management is a dynamic process in sync with the requirement at that point of time," said Soumyajit Niyogi, associate director at India Ratings and Research. 

“Need of Liquidity operation arises because of changes in both autonomous and discretionary factors. Therefore, which tool or combination of tools to be used to iron out such aberration is necessarily dynamic and non-committal. With better information dissemination and consistency over time, a central bank can align market expectations and action by the central bank,” Niyogi said.