RBI’s New, Wel­come Stress on Liq­uid­ity

Rate cut’s good news, liq­uid­ity fo­cus even bet­ter

The Economic Times - - The Edit Page -

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.

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