11 public sector banks under PCA aided in liquidity scare in September

By relaxing LCR by 2 percentage points, the RBI freed up Rs 2 trn worth of liquidity in the banking system

The 11 public sector banks (PSBs) under prompt corrective action (PCA) were partly responsible for a liquidity scare in September. The restrictive framework of the Reserve Bank of India (RBI) meant that banks had restrictions on how to deploy their money, and at the same time remain high on liquid assets. Therefore, when the IL&FS saga erupted, these banks liquidated their mutual fund holdings and put the money back with the RBI. 

Experts said the PCA banks parked between Rs 500 billion and Rs 600 billion with the RBI, which explains why there was such a heavy surplus of liquidity deployment even as the system was borrowing about Rs 1.9 trillion from the RBI at the same time. The funds parking peaked at the end of September. As on October 1, when the RBI’s relaxations regarding liquidity coverage ratio (LCR) came into effect, the banking system on a net basis borrowed just Rs 4.77 billion from the market. Compared to this, the market had a net liquidity deficit of Rs 1.44 trillion as on September 24.

On Wednesday, a set of banks borrowed Rs 1.625 trillion, whereas the other set had excess liquidity of Rs 1.621 trillion that they parked with the RBI. By relaxing LCR by 2 percentage points, the RBI freed up Rs 2 trillion worth of liquidity in the banking system. A senior official of a Mumbai-based PCA bank said the bank liquidated its mutual funds holdings, but could not deploy the fund in other avenues. Instead, the money was parked with the RBI. There are other reasons why PCA banks continue to hold excess liquidity, without being able to release it in the market. RBI’s PCA framework prevents them from free treasury operations and puts a cap on their lending exercise. “In terms of PCA banks, it is more to do with the price of money than the quantity of money. PCA banks continue to grow their deposit, while there are regulatory constraints in their ability to lend. The surplus amount mobilised is in turn deployed with the RBI or in sovereign market instruments,” said B. Prasanna, group executive and head of markets at ICICI Bank.