Economy

RBI working group calls for reviving bank rate, fixing it 50 bps above repo rate

Our Bureau Mumbai | Updated on March 15, 2011

Mr Deepak Mohanty





The Reserve Bank of India may reactivate the defunct bank rate (BR) by providing banks liquidity under a new collateralised Exceptional Standing Facility (ESF) at this rate.

A working group on the operating procedure of monetary policy has recommended the institution of a collateralised ESF at the BR up to one per cent of banks deposits.

The BR should be pegged at 50 basis points over the repo rate (the interest rate at which RBI gives funds to banks). Currently, the repo rate is at 6.50 per cent and BR is at 6 per cent.

In 2004, the RBI completely delinked the standing liquidity facilities to banks from the BR.

Hence, the repo rate emerged as the lending rate of the RBI for all practical purposes. As a result, the importance of the BR as a monetary policy instrument waned.

Referring to the fact that in the recent episode of liquidity tightness, the RBI has been providing additional liquidity up to 1 to 2 per cent of banks deposits on an ad hoc basis at the repo rate, the Group said this facility should be extended on a standing basis.

Advantages

The advantages of the ESF will be four-fold. First, it will provide an upper bound to the policy rate corridor. Second, it will provide a safety valve against unanticipated liquidity shocks. Third, it will help stabilise the overnight interest rate around the repo rate in a liquidity deficit situation. Fourth, it will enhance the liquidity attribute of banks portfolio of government securities without compromising its prudential nature.

Even as the BR will be fixed at 50 basis points above the repo rate, the reverse repo rate (the interest rate that banks earn from RBI for parking surplus funds) will be at repo rate minus 100 basis points.

The optimal width of the policy corridor should be fixed at 150 basis points and should not be changed under normal circumstances. The repo rate will operate within a corridor set by the BR and the reverse repo rate.

Surplus cash balance

To improve liquidity management, the Group, headed by Mr Deepak Mohanty, Executive Director, RBI, said a scheme of auctioning of the government's surplus cash balance at the discretion of RBI should be put in place in consultation with the government.

“In the last few months when the banking system was experiencing liquidity crunch of over Rs 1 lakh crore, the government had parked surplus resources with the RBI. These resources were just lying idle with the RBI. So, the Group has found a via media to beneficially utilise the idle surplus to iron out liquidity mismatches,” said Dr Golaka C. Nath, Senior Vice-President, Clearing Corporation of India Ltd.

The RBI's suggestion raising the minimum level of reserves to be maintained on any day by banks with the RBI during a fortnight from the present level of 70 per cent to 80 per cent of the required cash reserve ratio could put liquidity under pressure, say bankers.

Published on March 15, 2011

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