RBI prods banks to cut investments in govt bonds

Deposit and lending rates will not see any significant change, as the RBI kept key policy rates unchanged in its monetary policy on Tuesday. But just as in the June policy, the RBI has gone a step further to free up banks’ funds to revive the investment cycle and facilitate transmission of policy rates.

This has been done by reducing the SLR (statutory liquidity ratio) requirement; mainly comprising government securities held by banks.

Through this reduction, the RBI has also helped banks move towards the Basel III guidelines on liquidity requirement, which will come into effect from January 2015.

The RBI has also reduced the limit on government securities maintained in the held-to-maturity (HTM) category. Banks will now have to take additional market risk if they choose to stock up excess government securities than mandated.

The total SLR requirement for banks has been reduced by 50 basis points to 22 per cent of deposits, freeing up close to ₹43,000 crore of funds.

But this move in isolation is not material enough to result in increased lending by banks. Banks continue to carry excess investments (3-5 per cent more than the mandated requirement) due to lack of viable lending opportunities and the comfort of parking funds in highly safe assets.

This has not changed much, even after the recent 50 basis points cut in SLR during the June policy.

But what could force banks’ hands is the reduction in the ceiling of government securities held in the HTM category. These securities need not be adjusted periodically to reflect their market value.

Currently, banks are allowed to hold more securities in HTM category than the mandated level of SLR. With 0.5 per cent cut in the HTM ceiling, the RBI has resumed its effort to align the gap between SLR and HTM, which started in May last year. The RBI had stalled this process, post the liquidity tightening measures in July 2013.

The RBI is now likely to do away with the gap between HTM and SLR limit (200 basis points currently).

This has two implications. From the banks’ perspective, this means lower flexibility in holding excess G-Secs beyond that mandated by the SLR. Adjustment of these securities to market value will now have to be accounted for in banks’ income statements.

The other implication is for the bond markets.

As banks’ appetite to invest in G-Secs reduces, bond prices will get impacted negatively. As bond prices and yields are inversely related, yields are likely to trend up. Yields on the 10-year G-Secs went up by 10 basis points on Tuesday after the monetary policy.

This also factors in a ‘long wait’ in rate cuts, given the policy’s comment on risks to the medium-term inflation target.

Banks are required to meet the guidelines on the minimum liquidity coverage ratio (LCR) set out by Basel III. The main objective of LCR is to ensure that banks maintain sufficient liquid assets to meet obligations in a 30-day stress scenario.

The LCR will be introduced in January 2015 with a requirement of 60 per cent, that is, the stock of liquid assets should at least equal 60 per cent of total net cash outflows in the stress scenario. This will be gradually increased to 100 per cent by January 2019.

On an average, the reserve requirement globally is in the 10-15 per cent range. India’s higher reserve requirement is mainly due to SLR, which is a close substitute for LCR. Hence, SLR is likely to be reduced to 16-17 per cent over the next four to five years, as LCR comes into full force.