The RBI has decided to reduce statutory liquidity ratio, the portion of funds which banks are required to park in treasury bills and other instruments, by 0.25 per cent every quarter beginning January.
The calibrated reduction in statutory liquidity ratio (SLR) will continue till it reaches 18 per cent. The current SLR is 19.5 per cent.
"This reduction in SLR holding is likely to free up Rs 1-1.5 lakh crore of funds in the next one and half year into the banking system," said Rajni Thakur, Economist, RBL Bank.
In the 'Statement on Developmental and Regulatory Policies' post announcing its fifth bi-monthly monetary policy review, the RBI said it will reduce the SLR by 25 basis points (0.25 per cent) every calender quarter until the SLR reaches 18 per cent of the net demand and time liabilities (NDTL) as part of aligning it with the liquidity coverage ratio (LCR).
The first reduction of 25 basis points will take effect in the quarter commencing January 2019, the Reserve Bank of India said.
The move may release funds locked in government securities and add to lendable liquidity. With inflation expectations lowered, this should not impact bond sentiment in a short run, said R K Gurumurthy - Head Treasury, Lakshmi Vilas Bank.
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Bonds have rallied on the back of announcement that open market operations will continue and future policy and rate stance will depend on incoming data -- implying a longer pause is the way forward, he added.
The RBI has kept the key repo rate -- at which it lends to banks -unchanged at 6.50 per cent. It also cut the retail inflation projection to range between 2.7-3.2 per cent during October-March or the second half of the current financial year.
Zarin Daruwala, CEO, India, Standard Chartered Bank said it was heartening to note that the RBI was ready to ease monetary policy to support the economy.
"The sharp reduction in the inflation forecast accompanied by planned SLR cuts should result in lower costs for borrowers," Daruwala said.
The economists and bankers see the gradual reduction in SLR as a surprise move on part of the RBI.
"Broadly, the policy is neutral for bond markets, though retains a positive bias, even as a progressive cut in SLR by 1.5 per cent to 18 per cent can reduce demand for Government bonds in the near term," said Kumaresh Ramakrishnan, Head - Fixed Income, DHFL Pramerica Mutual fund.
A reduction in SLR would mean higher liquidity for the banks, so they would have more funds to lend. This would keep lending rates stable or push them down marginally, BankBazaar CEO Adhil Shetty said.
The SLR is the reserve that the commercial banks in India are required to maintain in the form of cash, gold reserves, government approved securities before providing credit to the customers.
Among others as part of the Statement on Developmental and Regulatory Policies, the RBI has proposed to allow NRIs to participate in the overnight indexed swap market for non-hedging purposes, subject to certain conditions.
The non-resident Indians (NRIs) are also being allowed to hedge their rupee interest rate risk flexibly, using any available IRD (image replacement document ) instrument.
In order to improve liquidity management by banks, the RBI also said that banks will be able to forecast their liquidity requirements with a greater degree of precision, as it will provide information on daily CRR balance of the banking system to market participants on the very next day.
Currently, the cash reserve ratio (CRR) balance of banks at the end of the day is being disclosed with a lag of 2-3 days, while the details of the currency in circulation are being released with a lag of one week.
The daily money market operations press release will contain the CRR figure for the previous day, with effect from December 6, 2018, the apex bank said.
The RBI also said it will rationalise the Borrowing and Lending Regulations under FEMA, 1999 by consolidating the regulations governing all types of borrowing and lending transactions between a resident Indian and a person resident outside India in both foreign currency and rupee, in consultation with the government.
"The proposed regulations, Foreign Exchange Management (Borrowing or Lending) Regulations, 2018 shall subsume the existing Notification No FEMA 3/2000-RB dated May 3, 2000, Notification No FEMA 4/2000-RB dated May 3, 2000 and Regulation 21 of Notification No FEMA 120/RB-2004 dated July 7, 2004," the Reserve Bank said.
It will also rationalise the extant framework for external commercial borrowings and rupee denominated bonds with a view to improving the ease of doing business.
The consolidated regulation and guidelines will be issued by the end of December 2018.