Uneven liquidity profile of large and small banks showed in September

With the Reserve Bank of India (RBI) offering to buy bonds worth Rs 360 billion from the market, and infusing additional liquidity worth Rs 2 trillion of by relaxing the liquidity coverage ratio (LCR), the asymmetric liquidity profile of Indian banks might get resolved.

 In the last week of September, it was apparent that one group of banks was liquidity-starved and borrowed heavily from the RBI, whereas the other (large banks) had excess liquidity, which they parked with the regulator.

Experts say, liquidity in the system is highly skewed in favour of large banks, particularly the public sector ones that are lenders in the overnight market. These have the huge deposit base, in the case of State Bank of India (SBI), roughly half of that is in low-cost current and savings accounts. Banks don’t pay any interest on current accounts, whereas for savings account, interest rates are as low as 4 per cent.

 Smaller banks, especially private ones, are aggressive in lending to individuals. However, they are at a disadvantage in deposit mobilisation, as the state-owned entities have government support and an implicit guarantee that deposits would remain safe.

This creates liquidity asymmetry. The public sector banks end up as lenders in overnight market, whereas private sector entities are typically the borrowers.

This was evident through September, through the repo window. On the other hand, a huge sum of surplus money was deposited with RBI. The net effect seemed to be that the system had adequate liquidity. 

With the quarter and financial half-year ending, banking system liquidity was strained due to advance tax outflow and goods and service-related payments.

As on Saturday, the system had borrowed Rs 1.83 trillion of liquidity. But at the same time,had parked excess liquidity of Rs 1.65 trillion.

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Taking the net number in this context won’t be right, say experts. The money market liquidity numbers for October 1 will be released on Wednesday, on account of a holiday on Tuesday.

 “Liquidity management by RBI should always be kept separate from the inflation management of RBI and as a separate policy tool,” said Soumyakanti Ghosh, chief economic advisor of SBI group. “A clear distinction must be made between short-term liquidity management to take care of frictional requirements through temporary repo injections and long- term permanent durable needs through open market operations (OMO),” Ghosh said.

 The liquidity imbalance is not permanent and it goes off when the government starts spending. Numbers suggest the government did start spending as the advance tax started crowding in, but that was not able to bridge the gap.

The RBI’s recent announcements would address much of these issues. The LCR relaxation of 2 per cent of the deposit base would allow banks to free up substantial amount of money for them. Banks can always sell their bonds to the RBI in OMO to gets more liquidity. 

So far this financial year, the RBI has done secondary market bond purchase of Rs 500 billion through five OMOs. Kotak Mahindra Bank research expects the RBI to conduct total OMOs of Rs 1.5-2 trillion for the entire financial year. 

“However, it is unlikely to completely offset the liquidity tightness implying that short-term rates would remain elevated,” the bank had said in a report.