Inter-Bank Bugbear

But a problem would certainly arise if this relaxation on inter-bank deposits, coupled with some other independent developments in the issue of gilts, leads to severe distortions in the gilts market. It would certainly be desirable to develop a proper yield curve through the creation of an inter-bank term deposit market but not at the cost of the shorter end of the gilts market. The RBI has fewer 91-day Treasury bills to offer because the government is not borrowing against them any more but simply running an overdraft. The banking system also has a lower demand for Treasury bills as a bank with excess short-term cash can now lend to another bank without providing commensurate reserves. If the RBI keeps looking at the ways and means mechanism and fixes the yield and quantum for 91-day Treasury bills at a great disadvantage to primary dealers, then the fault for that cannot lie with abolishing reserve requirements for inter-bank deposits. A healthy money market presupposes a healthy gilts market and regulation must work towards that.

Under the new dispensation, the net position of the banking sector and its demands for either cash or gilts will emerge much more clearly and there will be no scope for excessive provisioning of reserves. Now, if the banking sector is strapped for short-term funds, call money rates and the demand for refinance will be high and the demand for Treasury bills low. If there is too much money around, the RBI will have to mop it up by placing securities with attractive yields and eventually lower the bank rate. The RBI has to help primary dealers survive and create a demand for gilts within this setup.

There is of course the risk that some poorly managed banks, notably among the nationalised ones, will misuse this new freedom. They could either over-borrow in order to temporarily show a rapid rise in deposits or over-lend to temporarily show a rapid rise in their lending business. But the check against that is the banks own prudential norms. For example, a bank cannot lend more than 25 per cent of its net worth to any one company (banking as well as non-banking) or 50 per cent of its net worth to any one group. Also, those banks taking inter-bank deposits will have to meet a 20 per cent capital adequacy ratio on such deposits. Finally, the reserve requirement on inter-bank deposits is not entirely gone as they will still attract 3 per cent CRR. The current distortions at the shorter end of the gilts market and the plight of the primary dealers are really hiccups that any new mechanism has to initially face before order is established.