RBI pushes more liquidity into the banking system
Dec 04, 2013
Source : The Times of India

 

DELHI: The RBI cut the penal rate of interest, among some of the measures it took recently to push the money market to normal conditions.

Further, it has taken steps to expand the financial markets by agreeing to lend to banks for a longer term.

The RBI reduced the rate under the marginal standing facility (MSF) by 50 basis points to 9%.

Further, it introduced lending to banks for seven days and 14 days, instead of the current practice of just one day. The longer tenure lending began from October 11 at rates based on bids by banks.

The current steps by the RBI will increase liquidity in the system. These measures are aimed at unwinding of the liquidity tightening that began in July to stem the currency slide that took the rupee to record lows.

Since mid-July, the RBI has made borrowing costlier as it believed that a lower interest rate was used to speculate on the rupee, leading to its collapse.

It reduced the amount banks can borrow against their excess government bonds holdings to 0.50% of the deposits, and increased the MSF rate by 200 basis points. It also raised the minimum cash reserve ratio (CRR) to be maintained to 99%.

In September, the RBI reduced the MSF by 75 basis points and raised the repo rate by 25 basis points, citing inflationary pressures. Of late, the rupee rallied by 10% since its record low as the US dollar inflows increased due to measures like attractive currency swap rates on non-resident Indian deposits.

The RBI has now reinitiated measures to ease the liquidity conditions by cutting the MSF rate. This reduces the gap between the repo rate and the MSF to 150 basis percentage points. Besides lowering the MSF rate, the RBI will also inject liquidity in the form of 7-14 day term repos at an additional 0.25% of the Net Demand and Time Liability (NDTL) over and above the 0.50% of NDTL for each bank.

The overall liquidity deficit has eased to about Rs 1.20 lakh crore as compared to a peak of Rs 2 lakh crore in September.

The government decided to provide additional funds to the public sector banks to enable them to extend more credit to certain sectors to stimulate demand and combat the slowdown in the growth rate. This additional amount of capital will be provided to banks to enable them to lend to borrowers in selected sectors at lower rates in order to stimulate demand.

As a result of these steps, banks which are more dependent on money markets will be impacted positively. The steps will help ease liquidity in the banking system. With greater liquidity, banks will be able to lend more. So, their home loan portfolios can increase.

With the festival season still on, this helps banks push more money into the markets as home loans. However, the RBI has to reduce the repo rate for a stronger impact on interest rates. Yet, the current measures can offset the impact of the recent repo rate increase and consequently the interest rates to an extent.

When the inflationary pressures ease and the RBI steps in to reduce the repo rate, together with these moves, it will enable a reduction in lending interest rates. Borrowers on a floating rate gain because now the interest rates are linked to the base rate and in case banks reduce their base rate, the interest cost reduces.

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