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Overnight rates continue to be volatile following the Reserve Bank of India (RBI)’s move to shift from overnight repo to term repo to meet banks’ liquidity needs. Bankers say the cap on borrowing via the liquidity adjustment facility must be increased.
They say the key for the success of the new framework was banks’ ability to construct a model which could forecast liquidity needs with minimum margin of error. Banks say this is difficult, since loan demand from large borrowers fluctuates.
Borrowing under the daily liquidity adjustment facility (LAF) window was capped at 0.25 per cent of banks’ net demand and time liabilities (NDTL) in April from the earlier 0.5 per cent. Banks want an increase in the cap.
Overnight rates have been oscillating in a wide range of seven to nine per cent.
“The NDTL of the system is close to Rs 85 lakh crore and the intra-day movement of funds can be very large. The overnight availability of money from RBI is only Rs 20,000-22,000 crore, besides the standing liquidity facility,” says Manish Wadhawan, head of interest rates, global markets, HSBC India.
He says the liquidity requirement of the system is so large that even a single bank can see an outflow or inflow of Rs 10,000-15,000 crore on a single day. “With banks required to cover their Cash Reserve Ratio (CRR) up to 95 per cent in the morning, any major inflow or outflow during the day causes huge volatility.”
Traders had requested the regulator to restore the borrowing limit under the daily LAF from 0.25 per cent to 0.5 per cent of NDTL. RBI has not been keen because it wants India to have a vibrant term repo market, too. The borrowing from this window is available to banks at 0.75 per cent of NDTL.
“Our intent is to keep the call money rate close to the policy rate and we will come out very shortly with any measures that we think might be necessary to further this process. We are examining what is required,” said Raghuram Rajan, governor of RBI, in a post-monetary policy interaction earlier this month.
Some experts believe conducting term repos more frequently could help to contain volatility in the overnight rates. “If there are daily term repos, the current phenomenon of people borrowing immediately the moment a 14-day repo is announced and sitting with surplus funds will go away. Then, hopefully, the system will start borrowing to the extent of the requirement,” says Ananth Narayan, regional head, financial markets, South Asia, Standard Chartered Bank.
He says term repos could even be done daily, with the same cumulative limit and if required, there could even be term reverse repos by RBI to suck out excess liquidity.
Term repo auctions were introduced by RBI in October 2013. Initially, liquidity was provided to the extent of 0.25 per cent of banks' NDTL and later, in the second quarter review of the monetary policy in 2013-14, was enhanced to 0.5 per cent of NDTL. Then, on April 1 this year, the limit was further enhanced to 0.75 per cent of NDTL.
Earlier this year, RBI has also conducted term reverse repos. However, these instruments have not been used extensively to suck out liquidity.
Narayan says even bringing down the daily minimum requirement of CRR, currently 95 per cent, can help. “This can be brought down to 90 or 85 per cent. That will give more flexibility to individual banks to manage daily liquidity mismatches,” he said.
