RBI frees up about Rs 2 trillion worth of liquidity for the banking system

The RBI said banks can now consider 2 percentage points of their statutory liquidity ratio as part of the liquidity coverage ratio

The Reserve Bank of India (RBI) on Thursday freed up about Rs 2 trillion worth of liquidity for the banking system by tweaking how the solvency ratio is calculated, effective October 1. The move comes against the backdrop of tightening liquidity in the banking system and rates shooting up in the money market.

However, the freed-up money will unlikely prompt banks to buy non-banking financial companies (NBFC) papers. Sources told Business Standard that banks told the central bank that they were not interested in buying NBFC debt papers for fear of rising mark-to-market losses.

“The RBI is doing the right thing. It has already done two open market operations (secondary market bond purchase), and now it has freed up the fund. What banks will do with the money is something up to themselves,” said Jayesh Mehta, head of treasury at Bank of America Merrill Lynch.  

While this helped drive down the yields of the 10-year benchmark bond by about 5 basis points (closed at 8.027 per cent), the short-term treasury yields spiked by 4 basis points. The overnight call money rates also rose by about 20 basis points to 6.50 per cent, or near the anchor repo rate. Incidentally, this is the rate at which the RBI wants the call money rates to remain. 

However, bank stocks continued to slide. Among the Bankex stocks, YES Bank led the fall, losing 9.14 per cent. 

The US Federal Reserve hiked its key policy rate by 25 basis points on Wednesday, and the RBI may follow suit on October 5. 

The RBI in a morning statement said banks could now consider an additional 2 percentage points of their statutory liquidity ratio (SLR) as part of the liquidity coverage ratio (LCR). 
 

According to the Basel III norms, banks are required to keep enough high-quality liquid assets to survive an acute stress scenario lasting for 30 days.

This is essentially what the LCR is. Since it is a flowing concept, the calculation of the LCR is a complicated task. However, bond dealers and economists estimate it to be around 19-19.5 per cent of the deposit base currently. 

The SLR, or the portion of deposit to be kept invested in government securities, is an India-specific requirement. Currently, the SLR is at 19.5 per cent. 

Ideally, the entire SLR should be part of the calculation for the LCR, and the long-term plan is indeed that, but before Thursday, only 11 per cent of the SLR was taken as part of the LCR calculation. 

On Thursday, the RBI said 13 per cent of the SLR would now be calculated for the LCR purpose. What this means is that banks now have an additional 2 per cent of their deposit base freed up for their use. This 2 per cent of deposit base amount to be about Rs 2-2.3 trillion for the system, considering the total banking system deposit base is about Rs 116 trillion.

“This should supplement the ability of individual banks to avail 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 said in a statement on its website. 

In addition, the RBI said it “stands ready to meet the durable liquidity requirements of the system through various available instruments depending on its dynamic assessment of the evolving liquidity and market conditions”.

Money market rates have shot up due to liquidity shortage in the system. While the banking system continues to borrow heavily from the RBI, to the tune of about Rs 1.88 trillion as of Wednesday, there is also some heavy surplus liquidity getting parked. 

According to Soumyakanti Ghosh, chief economist at the State Bank of India group, “credit lines may have been disturbed to entities like mutual funds and the surplus money through redemptions is seeking avenues elsewhere.”

However, the measures could potentially also hurt the bond market in the longer run. 

“Under the new arrangement, instead of additional demand creation, demand destruction will happen for medium to long end of the curve,” said Ramkamal Samanta, vice-president, investments, Star Union Dai-Ichi Life Insurance.

“Hence, medium to long end of the curve, which is more driven by demand and supply will likely to go up. Supported shorter end and higher longer end yield will result in steep yield curve going forward,” Samanta said.