Before the Reserve Bank of India’s (RBI’s) annual monetary policy announcement, I had recommended a reduction in the statutory liquidity ratio (SLR) by 100 to 200 basis points to improve the liquidity in the system without affecting the money supply. The suggestion was made because, even though the system had surplus SLR, it was unevenly distributed as a result of which those with excess securities could engage in arbitrage operations. For banks with surplus securities, the availability of repo funds at eight per cent is an incentive for arbitrage in call money, commercial paper, certificate of deposit and treasury bill (T-bill), besides providing refinance for their lending operations. The treasury departments of banks have a mandate to make money, inter alia, exploiting arbitrage opportunities that arise every moment thanks to the computer and the real-time flow of market data. Besides reducing the repo rate by 50 basis points, RBI announced, on April 17, an increase in the borrowing limit of scheduled commercial banks under the marginal standing facility (MSF) from one per cent to two per cent of their net demand and time liabilities. This would mean a dilution in the SLR requirement by two percentage points – as I had suggested – but at a cost. However, the relaxation has not made any difference to the so-called shortage of liquidity in the system that supposedly gets reflected in repo operations. The repo transactions ranged between Rs 80,200 crore on April 17 and Rs 119,320 crore on April 26 without access to MSF. Earlier, I had questioned reports on the shortage of funds in the system and the practice of measuring it through repo transactions.
Can a bank raise funds at the repo window not for meeting its temporary deficit in cash flows – envisaged under the liquidity adjustment facility – but for either onlending to customers or other banks, or for investments in government securities or money market instruments? According to RBI, using repo funds in the call money market is part of normal inter-bank transactions. But it is silent on the use of funds in other lending and investment operations of banks that is facilitated by the rollover of repos day after day, week after week, making them virtually short-term (re)finance.
At the 91-day T-bill auction on April 26, 2012, RBI received bids for Rs 24,024 crore against the offer of Rs 9,000 crore — a bid-cover ratio of 2.66, the highest in recent memory. Still banks complain about the scarcity of funds! The cut-off yield was 8.3946 per cent against the repo rate of eight per cent. It means that RBI was making funds available to banks at the rate of eight per cent so that they could buy T-bills yielding more, thus making a tidy profit. I have been told by the Bank of England and the European Central Bank that they are not concerned about the end-use of repo funds. This may provide some comfort to RBI on its own stand. But there is a caveat. Western central banks do not have any SLR and, hence, the kind of situation observed in India is not seen there. Repo lending is created money and, at a time of tightening, banks with surplus securities borrowing from the central bank for onlending to others constitutes a leakage in the administration of the policy. The availability of repos in massive amounts day after day is equivalent to a reduction in the cash reserve ratio (CRR) that can range from one per cent to two per cent depending on the repo funds made available. RBI may as well reduce the CRR since that would benefit all banks instead of a few, as it is now at present. RBI needs to revisit this issue, if it has not done so already. It need not be guided by the central banks of the West since the conditions are different in India.
The increase in the borrowing limit for eligibility under MSF does not address the basic problem of banks that are just managing their CRR and SLR obligations. They need not go for MSF and pay nine per cent when they can raise money at a lower rate, though above eight per cent, in call money. MSF has rarely been used. The reduction in SLR does not affect money supply. Will it not affect banks’ subscription to fresh issues of securities in a year when massive borrowing is planned? The answer is “no”. We have seen excess SLR investments in the past even when growth of non-food credit was good. It was because, both for maintaining prudential ratios and for avoiding the rising trend in non-performing assets, banks prefer investment in gilt-edged securities. A deputy governor of RBI once characterised this tendency as “lazy banking”. Second, with the massive limit of Ways and Means Advances from RBI to the government at Rs 50,000 crore and the possibility of conducting buybacks, the central bank can always ensure that the government’s needs are met. Since there is no release of impounded funds, there is no relaxation of the central bank’s basic stance of tightness. At the same time, from the point of view of public relations, reducing the SLR by two percentage points will give the impression of improving liquidity. It will be a win-win situation for RBI.
The author is an economic consultant and a former officer-in-charge in the department of economic analysis and policy at the Reserve Bank of India