Dr. Madhavankutty G
Head – Banking, Economy & Policy – ET Prime, Times Group
Impact of measures announced by RBI on March 27 & April 17, 2020 as a relief against Covid-19.
1) Cash Reserve Ratio (CRR) reduced from 4% to 3%
Cash Reserve ratio refers to the percentage of deposits (more specifically net demand & time liabilities) that banks have to mandatorily park with RBI. It had been retained at 4% of total deposits of banks for a long time. On March 27, this has been brought down to 3%, which means an additional 1% of deposits of individual banks (liquidity) has been released to the banking system. For the banking sector as a whole, this translates to
र 1.37 lakh crore of extra funds. The idea is to provide extra liquidity to banks to lend more to the economy.
Liquidity is not a problem for banks. However two sets of issues are causing liquidity to remain idle with banks. 1) After the IL&FS crisis, banks are reluctant to finance even better rated NBFCs. Out of 10000 odd NBFCs, hardly 400 are of investment grade (credit-worthy) which makes it difficult for banks to deploy their funds. 2) Low demand for credit due to the ongoing slowdown which means funds lying idle.
So banks are forced to park their funds in Government bonds as it will give them at least some return (6.5-7%) which is better than the funds lying idle. So CRR cut may not have great impact on credit off-take.
2) Targeted Long Term Repo Operation (TLTRO) 1.0 and 2.0 introduced
Repo ’means repurchase operation. Repo is a transaction by which dealers borrow from the market by giving government bonds as a security with an agreement to repurchase or buyback the same security at a later date and return the money borrowed with interest. The interest rate is known as the repo rate. Banks also borrow from RBI in a similar manner. If the transaction is for one day it is known as an overnight Repo and the transaction for more than a day is known as a term repo. The rate at which RBI lends to banks overnight in this transaction is known as repo rate which is currently 4.4%.
On March 27, RBI introduced first targeted Long Term repo for
र 1 Lakh Crore at the rate of 4.4% for a 3 year tenure. As the name suggests, this is targeted for a specific purpose and 50% of the money borrowed by banks through this repo deal has to be invested in commercial papers and bonds issued by NBFCs and Mutual Funds.
The second TLTRO for
र 50,000 crore @ 4.4% for 3 years was announced on April 17. 50% of the money from TLTRO 2.0 to be deployed in investment grade instruments of MFIs, NBFCs with asset sizes of below र 500 Crore and NBFCs with asset sizes between र 500 Crore and र 5,000 Crore in the ratio 10:15:25 within 45 days from the date of availment. RBI releases funds through auctions.
Three year money at 4.4% is really cheap. This is as good as a rate cut and helps banks to lower their cost of funds. However, they will face a challenge in deployment as not many NBFCs are investment grade (credit worthy). Because of the same reason when RBI conducts TLTRO auction there may not be enough interest. For instance, the first TLTRO 2.0 auction for
र 25,000 Crore conducted on April 23 saw bids worth only र 12500 Crore
3) Limit under marginal Standing facility (MSF) hiked from 2% to 3% of SLR (statutory Liquidity ratio) funds
MSF is an overnight window provided by RBI which can be used by banks in need of emergency funds when other windows are exhausted. The collateral is Government bonds. The rate of interest is 4.65%. Statutory liquidity ratio is the amount of deposits that banks mandatorily invest in government bonds. RBI has permitted banks to dip into their SLR upto 3% from 2% earlier for government bonds as collateral. A 1% increase will enable banks to borrow an additional
र 1.37 Lakh Crores through this window in case of an emergency.
4) Repo rate reduced by 75 bps to 4.4% and Reverse Repo rate by 115 bps to 3.75%
As said earlier repo rate is the rate at which RBI lends money to commercial banks against govt bonds. A reduction in this rate is a signal to banks to reduce their lending rates and bring overall interest rates lower. Reverse repo rate is the rate at which banks lend money to RBI by accepting govt securities as collateral. A reduction in reverse repo rate is to disincentivize banks from paring funds with RBI but instead lend out.
Banks may not reduce their lending rates despite RBI cutting repo due to several reasons.
1) Banks lend funds not from repo borrowings but from deposits. Repo is a very miniscule portion of a bank’s liabilities to make any impact on its cost of funds. For eg as on date total banking system deposits are almost
र 133 Lakh Crore while repo outstanding averages hardly र 2 Lakh Crore. So a 0.75% cut in repo has no impact. What is needed is a deposit rate cut to enable lending rate cut to protect profits (margins)
2) Rising NPAs (Non Performing Assets) are leading to loss of income for banks and they don’t want to lose more income by cutting lending rates.
Reverse repo rate cut will not force banks to lend since credit demand is weak due to slowdown.
5) Capital Conservation Buffer (CCB) deferred till September 2020
This is the amount of capital banks must set aside as a cushion during good times to guard against bad times. It was to be 2.5% by March 2020, to be done at the rate of 0.625% every year. This has been deferred to September 2020. So temporarily it means lower capital lock in and hence some funds will be released for banks which they can lend out if there is demand.
6) Liquidity Coverage ratio reduced from 100% to 80%
Liquidity coverage ratio is the ratio of liquid assets which has to be mandatorily held by a bank to the amount of cash outflows in the next 30 days. Simply means how much the liquid assets can cover cash outflows. This has been reduced from 100% to 80%.This will not have much impact as banks were anyways maintaining this ratio at much more than 100%.
7) Moratorium on term loans and working capital loan repayment from March 1, 2020 to May 31, 2020:
(This period to be excluded for NPA classification.)
If a customer chooses he can get his interest on loan repayment deferred during the above period. This is done as a temporary covid relief. However, interest isn’t waived. It is only deferred. So from June onwards a customer will have to pay interest in the normal course and also the accumulated overdues from March 1 to May 31 along with interest thereof. This will actually increase his payout and he may be better off not availing the moratorium.
Moreover banks have been asked to make a provision (set aside capital) of 10% during the moratorium which will reduce their profitability.
8) Exempting banks from paying dividend.
This will increase banks’ profitability but will reduce the attractiveness of banking stocks.
9) Banks with branches in International Financial Service centres (IFSC) permitted to participate in NDF (non deliverable forward) market with effect from June 30, 2020:
As stated in the previous week note, there is an active market for INR in major financial hubs like Singapore, London, Dubai and Hong Kong. Volumes are as big as the domestic rupee market. A presence there by domestic Indian banks definitely helps in gaining better insights into INR movements offshore. So one advantage of permitting banks in NDF market is that it helps reduce volatility in exchange rate. However, there are also concerns that it could reduce onshore INR trading volumes.
Impact in a nutshell
|1||CRR reduced from 4% to 3%|| |
|2||TLTRO 1.0 and 2.0 announced||Low cost of funds for banks but lack of quality NBFC paper to invest may reduce banks’ appetite|
|3||Limit under MSF increased from 2% to 3% of SLR funds||Banks can access extra |
|4||Rep o rate reduced to 4.4% and reverse repo to 3.75%||Not likely to prompt banks to reduce lending rate since banks lend from deposits and repo borrowing is very small % of total liabilities to have any meaningful impact on cost of funds. Also banks are risk averse and credit demand itself is slow.|
|5||Capital conservation buffer requirement of 2.5% to be achieved only by September 2020||Less capital locked in and more funds made available for lending.|
|6||Liquidity Coverage ratio reduced from 100% to 80%||Banks already maintain LCR of around 110%. So this has negligible impact on liquidity.|
|7||Moratorium on interest payments from March 1 to May 31. Asset classification to be unchanged but banks to make 10% provision||This means only deferral and not waiver. So overdues will accumulate from June 1. Actually would be better off not availing this. 10% provision to reduce banks profitability.|
|8||Banks exempted from paying dividends for FY 2019-20 and till further restrictions||Banks profit to increase but interest in bank stocks to decline|
|9||Banks in IFSCs can participate in offshore INR trades||Helps to reduce volatility in USD-INR movements.|
1) Bank A has
र 100 deposits. It has to keep 4% with its banking regulator as Cash Reserve Ratio (CRR). However there was a sudden crisis and the regulator did away the CRR requirement altogether. How much extra funds will Bank A get?. Will this lead to more credit growth?
2) Due to the sudden outbreak of an epidemic, lockdown was imposed in country X and slowly it drifted towards recession. To combat this, its central bank reduced repo rate by 1%.to spur economic activity. What would be the impact?
3) Due to default of a leading non-bank lender in a country there was a sudden financial crisis. Its central bank introduced targeted repo operations and mandated banks to invest 25% of funds availed through it in NBFCs. How successful would such targeting lending be?
4) Despite RBI reducing repo rate to 4.4% from 5.15% recently, Kerala State Government Bond, for instance, was auctioned a very high coupon of 8.90% recently. Why is there such a discrepancy? (hint: fiscal situation)
5) One particular Friday Bank X found that there was a sudden withdrawal of a huge sum by a corporate which was unanticipated. Normal funding markets were already timed out by then. If it did not get funds it would default on maintenance of CRR the next day which is a statutory obligation. What would bank X do ideally? (Hint: MSF)
6) XYZ bank loaned Rs 1 lakh to a shop-owner of January 15. However, he didn’t repay the loan on March 15 when the 90 day period expired. Is the account standard or NPA at present?
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