LCR steals SLR's thunder: India adopts a modern measure of bank liquidity

The decades' old method of impounding bank deposits is making way for a more robust system

The Reserve Bank of India’s (RBI) decision to bring down the statutory liquidity ratio (SLR) by 25 basis points to 18 per cent from 19.5 per cent as on date would have normally made for screaming headlines, but it did not. Why so?

It’s because the SLR - the share of deposits maintained in bonds - is an old concept almost unique to India now and kept alive to help fund the Centre’s deficit. The international standard for measuring the liquidity of a bank is the liquidity coverage ratio (LCR). 

Effective January 2019, the LCR is to be minimum 100 per cent of the total net cash outflow on an ongoing basis; it is now at 90 per cent. Under assets which are counted towards High Quality Liquid Assets (HQLA) are government securities (G-Secs) in excess of the minimum SLR norm. So, in effect, the more the RBI cuts the SLR floor, the more it frees up extra assets (bonds) to be considered as HQLA under the LCR.

Now, why is it that it doesn’t matter anymore if SLR is cut progressively? To start with, that was the plan anyway. LCR is scheduled to take over and SLR is to be phased out eventually. It was expected in 2015 that it would take five to 10 years to abolish it. The minimum SLR now is 19.5 per cent. The systemic SLR as on date stands at 25-26 per cent of the deposit base, or 5.5 per cent or Rs 5.5 trillion of extra bond holdings above the mandatory SLR limit. 

“Some banks will be benefited by the release of liquidity, but overall, it doesn't have much of an impact on the bond market as the banks are anyway sitting on excess bond holdings,” said Soumyajit Niyogi, associate director at India Ratings and Research. 

Then and now

Now flash back to September when a similar move had an immediate effect. That time, the RBI said that 13 per cent of the 19.5 per cent of SLR could now be considered to be LCR. The portion allowed earlier was 11 per cent. This two per cent leeway immediately freed up Rs 2-2.3 trillion worth of productive liquidity for banks. 

 “This should supplement the ability of individual banks to avail themselves of liquidity, if required, from the repo markets against high-quality collateral. This, in turn, will help improve the distribution of liquidity in the financial system as a whole,” the central bank had said in a statement that time. 

It also needs to be borne in mind that in September, money market rates had shot up because banks were reeling under a liquidity crunch as credit growth perked to over 15 per cent near end-November, from just 12.5 per cent in end-September.

However, the situation could be a bit different now. The liquidity shortage is not so acute, thanks to various liquidity operations by the RBI. Through its open market operation (OMO), the RBI has infused more than Rs 1 trillion of liquidity in the banking system since September. In the whole of December, the central bank will be infusing Rs 400 billion of liquidity through secondary market bond purchases under OMO.

RBI’s Deputy Governor Viral Acharya said at the December policy press conference that such liquidity support may continue till March. Therefore, the liquidity need is not so acute now as it was in September. 

Credit growth, though, is gathering steam. Capacity utilisation at near 75 per cent is encouraging as, beyond this, capacity expansion takes place. But the issue is that much of the banking system liquidity is skewed in favour of large state-run banks and they tend to invest in G-Secs for want of a better avenue.
 

“It is a demand destruction for bonds, but will create liquidity, which should be bond positive in the medium term,” said Ramkamal Samanta, vice president, investments, at Star Union Dai-Ichi Insurance. 

So even if SLR reduction brings down the so-called demand for government bonds, the improved liquidity aids in investment. At a time when the central bank has guided lower inflation for the next one year, and bond yields are falling, the treasury departments of Indian banks will likely continue putting their money in government bonds.

A new order cometh

|  The SLR is an old concept unique to India, kept alive to help fund the Centre’s deficit

|  The LCR is the international yardstick of how liquid a bank is 

|  In September, the markets reacted immediately as 13 per cent of the 19.5 per cent SLR was considered to be LCR, up from 11 per cent

|  The 2 per cent leeway three months ago had freed up Rs 2-2.3 trillion worth of productive liquidity for banks