Liquidity crunch forces banks to offload dollars

Re surplus banks, however, opt for arbitrage overseas

Nationalised banks have turned to selling dollars to raise rupee resources amidst signs of tightening liquidity conditions in the banking system.

The Reserve Bank of India (RBI) today received only three bids for only Rs 350 crore at its one -day repo auction.

As a result of the tight money conditions, the overnight call money market rate has shot up to 5.50 per cent, way above the lower band of the "interest rate corridor" of 4.75 per cent, set by the repo rate. On Wednesday, the central bank had received bids for only Rs 500 crore.

This is a far cry from the bids of Rs 50,000 crore-plus on the repo window six months ago and of Rs 15,000-20,000 crore even a month back. Call money rates, which hadn't budged above 4.50 per cent in almost last one year, are finally showing some signs of an upward bias.

Dealers said nationalised banks had been selling dollars on an outright basis to generate rupee resources for themselves. A surge in credit offtake in recent weeks has forced banks to cut back their lendings in the overnight money market. Further, the 50 basis point cut in the cash reserve ratio (CRR) in two tranches has already drained out around Rs 7,000 crore from the banking system.

Dealers said the rupee-surplus banks are refraining from lending in the overnight money market, as they are investing in the overnight US money markets to benefit from a clear 30-40 basis point arbitrage available.

The chief dealer of a private bank explained that cash-surplus banks are active in dollar-rupee swap markets. Typically, banks buy dollars now and pay rupees to the seller. The reverse leg of the swap involves a dollar sale. These dollar funds are invested in overnight interest on the dollar balances overseas and the swap premium.

Dealers said with overnight interest rates at 1.80 per cent (annualised) and swap premium at 4.0 per cent (annulaised), banks earn at least 5.80 per cent on dollar assets against 5.50 per cent in the domestic call money markets.

Such swaps are also rife in the near term maturity of one month where bank could buy dollars out of rupee funds and receive premium of around 4.31 per cent.

These are invested at one-month Libor rates of 2.05 per cent. So banks could earn 6.36 per cent against 5.26/28 per cent earned if the rupee funds are lent in the domestic overnight interest rate swap market.