IndusInd Bank case a rare instance when RBI cited its 'LOLR' role

Central bank can rescue a bank that is solvent but has temporary liquidity woes

In the last 25 years, there were a few instances when the Reserve Bank of India (RBI) made public statements on commercial banks, reassuring their financial health while asking depositors not to panic or react to speculative reports.

 

The latest lender for which RBI has made an appeal is IndusInd Bank.

 

An accounting error leading to a loss of 2.35 per cent of its capital, estimated around ₹1,500-2,000 crore, resulted in the stock tanking over 27 per cent last Wednesday.

 

On Saturday, the RBI made a statement appealing to depositors that there is no need to react to the speculative reports at this juncture while affirming IndusInd’s stable financial health. It also added that the bank is being monitored closely by the regulator.

 

Saturday’s statement also highlighted that the RBI has directed the Board and the management of IndusInd to have remedial action completed fully during the current quarter — Q4FY25 — after making the required disclosures to all stakeholders.

 

The RBI also highlighted the strong capital adequacy ratio of IndusInd Bank (16.46 per cent), provision coverage ratio (70.2 per cent), and liquidity coverage ratio of 113 per cent as on March 9, compared to 118 per cent in end-December — much above the regulatory requirement of 100 per cent.

 

Earlier on April 12, 2003, panic had struck ICICI Bank customers. The regulator had to come up with a press release clarifying that ICICI Bank has sufficient liquidity, including in its current account with the RBI, to meet the requirements of its depositors.

 

“ICICI Bank's financial position is also sound,” the press release said. The statement was necessary due to rumours that the private sector bank was facing liquidity problems, and depositors are withdrawing cash at its ATMs and branches in Gujarat.

 

Then again on March 5, 2020, RBI, while placing YES Bank under moratorium with a withdrawal cap of ₹50,000, reassured the depositors that their interests will be fully protected and there is no need to panic.

 

Former RBI Governor Shaktikanta Das, after a few banks’ shares were hit on the onset of Covid in 2020, had said that share prices have nothing to do with the safety of deposits.

 

“In the recent past, Covid-related volatility in the stock market has impacted share prices of banks as well, resulting in some panic withdrawal of deposits from a few private sector banks. It would be fallacious to link share prices to safety of deposits,” Das had said.

 

One of the reasons why the RBI made these occasional statements to calm depositors is because as a banker to banks, the RBI also acts as the ‘lender of the last resort’ (LOLR). In the case of IndusInd, the RBI had to flag its LOLR role. 

 

The RBI can come to the rescue of a bank that is solvent but faces temporary liquidity problems by supplying it with the much-needed liquidity when no one else is willing to extend credit to that bank.

 

The apex bank extends this facility to protect the interests of depositors and to prevent possible failure of the bank, which, in turn, may also affect other banks and institutions. It can have an adverse impact on financial stability and the economy as well.

 

In a speech on November 2022, the then deputy governor of RBI, in-charge of monetary policy, Michael Patra, quoting Walter Bagehot’s ‘Lombard Street: A Description of the Money Market,’ said “The central bank had one objective: lending freely against good collateral at a penalty rate.”

 

“Being the lender of last resort was its only function so as to avert financial panics and confidence runs… Scratch a central banker and underneath the skin, this age-old commitment to financial stability is always revealed,” Patra had added.