Weighted average call rate anomaly needs to be fixed, says RBI research

It has been the Reserve Bank of India’s (RBI's) stated objective that the banking system liquidity is comfortable as long as the weighted average call rate (WACR) is below the policy repo rate. But this does not take into account the skewed liquidity pattern that exists between banks.
 
While one set of banks poses liquidity in surplus, the other suffers from an acute deficit. Banks under prompt corrective action (PCA) also does not participate much into the call money market, thereby skewing the liquidity pattern even further. A staff study published in the RBI’s February bulletin shed some light about the reasons for this asymmetry and the need for checking the market microstructure.
 
The fact that the market microstructure needs fine-tuning reflects in episodes where the call money rates traded below the repo rate even after surplus conditions in the first quarter of 2018-19 ebbed and systemic liquidity was tight, warranting net injection through repos between September and December last year.
 
The liquidity profile has now improved across all banks, thanks to the record Rs 2.7 trillion worth of liquidity infusion by the central bank through secondary market bond purchases.
 
The RBI bulletin, released on Wednesday, blames three critical factors for the anomalous behaviour of call rates vis-à-vis the policy repo rate.

 
The report has been authored by Indranil Bhattacharyya, Samir Ranjan Behera and Bhimappa Talwar of the Monetary and Liquidity Analysis Division, Monetary Policy Department of the Reserve Bank of India. The authors found that most of the co-operative banks are not participants in the call money market trading platform.
 
“Non-scheduled co-operative banks, District Central co-operative banks and State co-operative banks tend to enter the interbank call money market late in the trading hours — after the closure of the collateralised market segments — and their lending activity increases during the second half of the day thus driving rates below the repo rate,” says the study.
Also, the first hour of trading in the inter-bank call money market usually accounts for about 75-80 per cent of the day’s volume as most of the market participants are unable to assess their flows for the day in the absence of a robust liquidity forecasting framework, and as a result, late hour demand-supply mismatches reflect in low call rates.

Finally, “the absence of uniform market hours across all money market segments (including the collateralised segments), which are not in sync with real-time gross settlement (RTGS) timings often have a destabilising impact on the WACR towards the market’s closure,” the authors said.
 

The central bank found an internal group in August last year to review timings of various markets and the necessary payment infrastructure for supporting the recommended revisions to market timings. The staff report recommends some measures that could find its reflection in the committee notes. According to the study, “announcement effects tend to dominate over liquidity effects”, meaning it is more powerful for the central bank to communicate its intention so that the market’s reactions to policy innovations are stronger and faster “than the responsiveness of actual cost of funds to system liquidity shifts engendered by the policy changes when they fully play out.”
 
According to the study, the 14-day repo, through which the bulk of primary liquidity is provided, “needs to replace the fixed rate overnight repo as the single policy rate".
 
Instead of just one-way buying or selling of bonds from the secondary market, the RBI should initiate two-way OMOs in a market-based framework. “The experience of 2018-19 also suggests that fine-tuning operations should be of short tenors and easily reversible, not overwhelming the durable liquidity operations,” it said.