Banks cautious over uncertainty around withdrawn Rs 2,000 notes

Lenders hesitate to deploy excess funds with the central bank due to uncertainty about the duration of recently withdrawn Rs 2,000 notes, affecting liquidity overall as loan demand remains strong

Don't want to miss the best from Business Standard?

Banks are being cautious about depositing their extra funds with the central bank because they are uncertain about how long the recently withdrawn Rs 2,000 notes will remain in circulation. Despite there being a strong overall demand for loans, this caution is putting pressure on liquidity according to a report by the Economic Times.

In recent variable rate reverse repo (VRRR) auctions conducted by the Reserve Bank of India, banks have, on average, only deployed 50 per cent of the amount offered by the central bank to absorb liquidity. Instead, they have preferred to keep more of their surplus funds at the RBI's standing deposit facility (SDF) window.

This hesitation to invest funds for a longer duration comes even though there has been a significant increase in surplus liquidity over the past few weeks due to government spending. The RBI has absorbed an average of Rs 1.87 trillion rupees of surplus funds from banks this month. Interestingly, the interest rate offered by the SDF is much lower than what banks could earn through the VRRR auctions. This indicates that lenders remain uncertain about future liquidity conditions.

The difference between the interest rates offered by the SDF and the VRRR auctions is 24 basis points. Therefore, banks prefer to place their surplus funds in the SDF, sometimes exceeding Rs 1 trillion on a daily basis added the report.

The SDF, which represents the lower limit of the interest rate corridor, carries an interest rate of 6.25 per cent. In contrast, the cutoffs at variable rate reverse repo auctions are set one basis point lower than the repo rate, which currently stands at 6.50 per cent.

Sacrificing the additional 24 basis points that banks could have earned from the VRRR auctions is a small price to pay for the certainty that they won't have to rush to the RBI's marginal standing facility (MSF) if they face sudden payment obligations and fall short of funds.