The RBI's announcement on July 31st 2012 following its Quarterly Monetary Policy Review (Q1 - FY 13) saw the SLR requirements for banks cut from 24% to 23% of NDTL (Net Demand and Time Liabilities). While the announcement has on one hand signalled liquidity relief/enhancement for the banking system and the economy thereby, the move has come in for a fair amount of criticism on financial news channels and websites alike. So, has the RBI missed a trick?
In the week preceding the 9th of July 2012, the liquidity deficit (banks’ borrowing from the RBI) in the system (LAF) had come down significantly from a high of Rs 90,000 crores to around Rs 10,000 crores owing to a host of reasons. The significant ones being: Banks had drawn about Rs. 25,000 Crores by availing the export credit refinance option after the RBI enhanced the limit of the export credit refinance facility for banks from 15% to 50%, a move that was expected to provide an additional liquidity of about Rs. 30,000 crores (Rs. 300 Billion). Apart from this, foreign fund inflows in the form of investments and government spending had contributed to the easing in tight liquidity. The prevailing liquidity situation coupled with a slow credit growth/expansion saw corporate bulk deposits losing sheen, with deposits that had thus far fetched double digit returns, finding very few takers. Banks were refusing bulk deposits even at interest rates offered to retail depositors, and while some banks did oblige, it came with a cap on the quantum of the deposits accepted. The return on three month deposits that was at about 9.5% has slipped below 9%.
While the net infusion of liquidity by the RBI through the LAF (liquidity adjustment facility – i.e. banks’ borrowing from the RBI) ranged from Rs 70,000 crores to Rs 1.9 lakh crores for over nine months, the withdrawals from the LAF window (banks’ borrowing from the RBI) as on the 31st of July 2012 had declined to around Rs. 40,000 Crores after having dipped to about Rs. 10,000 crores as on the 9th of July 2012. The liquidity deficit under the LAF was well within the RBI's indicated comfort zone of 1% of NDTL, roughly about INR 55,ooo crores.
Coming to the SLR holding by banks, banks have been holding an excess SLR of about 3-4% on an average, due to a lack of avenues (or inclination?) to lend, especially given the threat of increasing NPA’s. The excess 3-4% SLR holding in monetary terms, translates to about INR 1.65 – 2.2 lac crores (considering 1% of NDTL to be about 55,000 crores). That, is roughly the amount that banks could have better utilized / lent out had they thought fit. So, in general, though the negative liquidity adjustment (LAF) figures suggest scope for liquidity improvement, at this point at least, this appears to be more a manifestation of choice rather than a lack of options, thus raising doubts about the effectiveness of the SLR cut. This brings me to the FAQs that have been flying around most articles/discussions related to the SLR cut:
Was liquidity really tight? Was the boost to liquidity really required at this stage?
A majority of the voices that have lent support to the RBI move have broadly echoed this statement by Brinda Jagirdar, general manager and head of economic research at State Bank of India who said, "Currently banks are sitting on excess SLR. Going forward, the situation will not remain the same. The busy season for loan off-take will soon kick off. Lenders will then require more liquidity support. Immediately after 50 bps policy rate cut in April, many lenders could not transmit the policy as liquidity situation was tight. With an easing liquidity condition, RBI now nudges banks to cut rates,". Interestingly, since the SLR cut, SBI has been the first bank to go ahead and cut lending rates (home and auto loan) by between 25-85 basis points, though none of the other banks have followed so far (as on 14th August 2012).
Even if one were to subscribe to that view, given that banks are holding an excess of SLR, the next set of questions that arise are:
Could the LAF (REPO borrowing by banks), which has in the past lent liquidity to the tune of INR 1.9 lac crores in the past, not have supported the liquidity requirements?
Could OMO’s not have been used to manage liquidity? OMO’s would have had the dual benefit of lowering yields and thus borrowing costs and at the same time, eased liquidity.
The argument that is being put forth by some is that the move was aimed at aiding some of the banks (primarily some of the small to mid-sized banks) that were facing tight liquidity conditions and weren’t holding an excess of SLR. If that be the case, neither the LAF, nor the OMOs would be of much help since both of these options can only be of help to banks with an excess SLR holding. In such a scenario, the options available to the RBI are, to tinker with either the SLR, or the CRR.
Shailendra Bhandari, managing director and chief executive officer, ING Vysya Bank saw the SLR cut as a positive move. "We now save on 1% of our SLR. If we borrowed at 9.5%, we put into SLR bonds at 8%, we lose 1.5%. So, we save that 1.5% on 1% of our deposits. So that comes to 1-1.5 bps on our margins." This explanation still leaves me with one unresolved doubt. Why not the CRR?
SLR cut? Why?
The reduction in the SLR requirement has resulted in bond yields (G-sec yields) rising by about 7-10 basis points, thus potentially raising the borrowing cost for a government that is raising about 15,000 crores every week from the bond markets. India’s fiscal deficit for Q1 in FY-13 has touched about 37% of the budgeted deficit for this financial year (5.13 Crores) as against a 39% deficit registered for the same period in the previous year. The apparent improvement however, is partly a result of a hike in Service Tax, Excise,and lower corporate tax refunds. We’ve already seen growth forecasts being revised downwards, thus potentially putting pressure on the government’s tax mop-ups. Now add to that a weak monsoon that might force enhancements in agriculture-related subsidies; and the possibility of exceeding the budgeted fiscal deficit and thus the budgeted government borrowing suddenly seems very real. And off course, a higher borrowing would mean that G-sec yields rise and raise borrowing costs. In this scenario, the SLR cut would additionally result in a greater over-supply of bonds thereby further raising bond yields, borrowing costs and consequently the fiscal deficit(which some analysts already see at 6%).
Why a CRR cut?
The common argument against a CRR cut has been that it would’ve directly infused liquidity into the system.
“Unlike a CRR cut, which results in immediate injection of liquidity across the system, an SLR cut is only a cushion that banks will have. Many banks have excess SLR and they may continue with that surplus. So there is no immediate trigger for an entry of this amount into the market,” Subir Gokarn, deputy governor, RBI, said after the monetary policy review.
However, assuming that a cut was actually necessary, in the given situation, I fail to understand how a CRR cut would’ve had any relatively adverse impact.If at all, I think it could only have helped.
Had there been a CRR cut, it would’ve eased liquidity for those who required it, while the rest of the banks would’ve continued allocating those funds towards SLRs for the same reasons that they have been doing so, so far. And, instead of having an adverse effect on bond yields, it would’ve probably lowered them at least in the near term, thus also helping the government’s borrowing program while still giving banks the liquidity cushion that the RBI wanted to give them. The only excess liquidity infused would’ve been the return on the funds released via the CRR cut (return on CRR deposits is 0%). Assuming an 8% return on SLR holding (based on average current G-sec yields) as opposed to a 0% return on the CRR requirement, on 1% of NDTL (assuming a 1% CRR cut), the excess return would’ve been about Rs. 4,400 Crores(considering 1% of NDTL to be about 55,000 crores). That excess return is much smaller than the amount of funds the RBI will probably pump in, to buy bonds, support the government’s borrowing program, bolster a reduced demand for G-secs and keep bond yields from going too high (And, we really need the banking system to absorb the government’s borrowing, so we shouldn’t even look at it as a cost).
The only explanation for me seems to be something I came across in a write up by Chanda Kochhar which reads, “Over the long term, the gradual reduction of pre-emption of bank resources through the Statutory Liquidity Ratio is desirable, and this reduction may be seen as a step in that direction.”
In terms of the timing of the move, one should note (to the RBI’s credit), the impact of the SLR cut on bond yields would’ve been far greater if it had been done when banks weren’t holding excess SLR. So in the given context, the adverse impact has been limited. Further, one way of looking at it is that, since the RBI has already cut the CRR earlier, they probably wanted to retain some extra leeway to cut the CRR at a later date when the liquidity requirement was greater than it is now, and in a scenario where they wouldn’t be able to cut REPO rates. But clearly, in an environment where the US, Europe, China and now Japan are slowing down, the RBI cannot keep interest rates unchanged (high) for too long unless they risk severely crippling the economy. So, given the risks attached to a ballooning fiscal deficit, could this have been saved for another time during a lower interest rate regime?
For a change I must say, one of the world’s best central banks has left me a little surprised.
Do share your thoughts/feedback.
Vikram Nagarkar
nagarkar.vikram [at] gmail.com
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