SLR may be cut to 20% to support liquidity coverage norms

Participants believe if the impact on markets is significant, Reserve Bank might decide to stop cutting the SLR

It is expected the statutory liquidity ratio (SLR), or the minimum bond holding requirement for banks, will be cut sooner rather than later.

Earlier this week the Reserve Bank of India (RBI) had reduced the ratio by 50 basis points to 22 per cent of banks’ net demand and time liabilities (NDTL), effective the fortnight beginning Saturday. At the central bank’s previous monetary policy review, too, the ratio was cut 50 basis points.

“RBI may reduce the SLR for banks to 20 per cent at the earliest if there is a leeway, without disrupting the government securities markets. This is because from January 1, 2015, the liquidity coverage ratio (LCR) norms will kick in and banks will have to manage liquidity ratios,” said Manish Wadhawan, managing director and head (interest rates), HSBC India.

LCR is the proportion of high-quality liquid assets to the total net cash outflows through 30 calendar days.

RBI has mandated banks to maintain 60 per cent LCR from January 1, 2015. It has also suggested the ratio be increased to 100 per cent by January 1, 2019, in a phased manner.

Wadhawan said the two important variables determining the pace of SLR cut would be the government’s fiscal position and the macroeconomic environment.

RBI Governor Raghuram Rajan has said the SLR was reduced because government finances had shown signs of an improvement, which provided room to free liquidity for the private sector. Banks have had an SLR of more than the requirement, amid sluggish credit growth. It is felt the impact of a cut in the SLR will be felt when economic activity picks up.

“SLR reduction will not just place more funds at the hands of banks to lend to the private sector, but also improve the function of the government securities market through better price discovery. It will also help in improving fiscal discipline,” said Rupa Rege Nitsure, chief economist and general manager, Bank of Baroda. The central bank was likely to cut the SLR again at its next policy review, scheduled for September 30, Nitsure added.

However, cutting the SLR hurts the bond market when government borrowing is high. Following the cut on Tuesday, the yield on the 10-year government bond rose 11 basis points on that day. The market is still reeling under the impact, due to which bond yields continue to be elevated. A cut in the SLR prompts banks to sell not-so-liquid securities that tend to raise bond yields.

This financial year, the government plans to borrow Rs 6 lakh crore from the market, compared with Rs 5.97 lakh crore in 2013-14.

“A further cut of 200 basis points will result in a large spike in yields and the yield on the 10-year bond could breach the nine per cent mark. But RBI may decide not to do it at a go. It may decide to combine it with rate cuts or announce these cuts when the bond market is bullish. This will help mitigate the adverse reaction,” said a bond dealer with a state-run bank.

Market participants believe if there the impact on the markets is significant, RBI might decide to stop cutting the SLR.

“The broader, longer-term programme of five years is we should reduce the amount of preemptions we have in the system, including SLR, and make a more effective priority sector lending process,” Rajan had said in a post-monetary policy conference call on Wednesday.