RBI slams banks for LAF misuse

Says they can’t lend liquidity adjustment facility funds in overnight money market.

Banks have come under fire from the Reserve Bank of India (RBI) for lending funds borrowed under the liquidity adjustment facility (LAF) in the overnight money market. LAF funds are meant to meet banks’ reserve requirement.

At least twice last week, RBI officials told bank managements about their discomfort with lending of LAF funds in the overnight money market. “The liquidity deficit, which shot up last week, made the regulator enquire about the reason. When it came to know that banks were doing arbitrage by lending the borrowed funds in the call money market, it reminded us that LAF funds should not be used for lending,” said a top executive of a public sector bank.

Last week, call rates went past 7 per cent on most days, while the repo rate — the rate at which banks borrow funds from RBI — was 6.5 per cent till Thursday’s first LAF. On Thursday, RBI raised the reverse repo and the repo rate by 25 basis points each to 5.75 per cent and 6.75 per cent, respectively.(Click here for table & graph)

According to banking industry officials, some foreign banks and small private sector banks did not have excess government paper to get LAF funds and so they were dependent on the overnight market. Banks that had government bonds in excess of the regulatory requirement of 24 per cent seized the opportunity to make a 50-75-basis-points margin in the call money market.

“RBI was unable to accept the fact that the liquidity deficit was so high even when the government had started spending, despite advance tax outflows,” said another executive of a government-owned bank.

During the November-January period, when a liquidity shortage was acute, banks were borrowing around Rs 1 lakh crore from RBI on a daily basis. However, from February, the quantum of deficit came down to the central bank’s comfort level of +/- 1 per cent of banks’ net demand and time liabilities, or Rs 50,000 crore. The deficit has come down since because the government has started spending, reflected in the fact that government balances with RBI fell from a high of Rs 1 lakh crore in the middle of December to Rs 100 crore — the minimum level the government should keep with RBI — in March.

Bankers said the liquidity strain last week was due to corporate advance tax outflow, estimated in the region of Rs 50,000 crore.