RBI’s New, Welcome Stress on Liquidity
Rate cut’s good news, liquidity focus even better
The RBI has cut the repo rate by another 25 basis points, bringing the cumulative reduction in the policy rate to 150 basis points. This was widely expected. But the central bank offered a pleasant surprise as well. There would be a step up in liquidity, which should help banks cut lending rates. After the central government’s decision to stick to fiscal discipline and bring small savings rates down, benchmarked against the yield on government bonds of like maturity, it would have been difficult for the central bank to not cut its policy rate, especially with inflation behaving, more or less. Now, it is the turn of banks to lower their lending rates, armed as they are with more room to lower deposit rates and a new way to set their lending rate, based on the marginal cost of funds.
The RBI’s focus is now shifting from rate reduction to liquidity measures. Lack of liquidity has hampered banks’ ability to translate reductions in the RBI’s policy rate into lower lending rates. The RBI now promises to enhance durable liquidity, to eliminate the liquidity deficit. The pre-emption of bank lending by making banks hold a proportion, called the statutory liquidity ratio, of their assets in government bonds will steadily come down. Banks will be allowed greater leeway in missing the cash reserve they hold on a daily basis. Further, the halving of the difference between the rate at which the central bank lends banks emergency liquidity (the marginal standing facility rate, which is above the repo rate) and the rate it offers on deposits accepted from banks (the reverse repo rate, below the repo rate) to 100 basis points will mean that market-determined call money rates will align better with the repo rate.
The RBI’s move to issue consultation papers on peerto-peer lending and on wholesale banks is most welcome. These are two ends of the credit spectrum that are underserved. As technology disrupts finance, regulation has to evolve to keep pace with the change. The only caveat is that a bank that focuses on large loans should not be seen as a substitute for a thriving bond market.