In a bid to calm shaken nerves and restore confidence in the market, the RBI brought in liquidity measures that could release about ₹2.5 lakh crore into the system.

The RBI increased the Facility to Avail Liquidity for Liquidity Coverage Ratio (FALLCR) from the existing 11 per cent to 13 per cent of banks’ net demand and time liabilities (NDTL), essentially implying that banks can now dip into government bonds held under SLR to the extent of 15 per cent of NDTL, which will ease up liquidity pressure in the banking system.

The recent turmoil following the NBFC crisis had led to a sharp uptick in money market rates, and the RBI’s measures could offer interim relief to the liquidity situation, cooling off short-term rates. However, skewed liquidity conditions across banks, risk perception, and the willingness of banks to borrow at higher Marginal Standing Facility (MSF) rates will be the key factors that will determine the extent to which funds are eventually released into the system.

Above all, the RBI will have to ensure that there is consistent liquidity infusion through OMOs – buying of government bonds – in the coming months, to cool off yields and sooth the market.

What it entails

Banks maintain a portion of their deposits (NDTL) as statutory liquidity ratio (SLR) in the form of government securities that are highly liquid and can be easily sold to raise money. Currently, while banks have to hold 19.5 per cent of deposits as SLR, they hold close to 28 per cent. Hence, they can pledge these securities to raise money at the repo window.

From January 2015, banks were also required to meet the guidelines on the minimum liquidity coverage ratio (LCR) set out under Basel III. The main objective of the LCR is to ensure that banks maintain sufficient liquid assets to meet obligations in a 30-day stress scenario.

The LCR requires that the stock of liquid assets should equal to 90 per cent (from January 2018) of the total net cash outflows over 30 days.

This will increase to 100 per cent by January 2019. As banks have to maintain such liquid assets over and above the mandated SLR requirement, the RBI has allowed banks to dip into a portion of their government bonds held under the mandated SLR requirement to count as liquid assets for computing LCR.

Currently, government securities under the MSF (2 per cent of NDTL), and FALLCR at 11 per cent of NDTL within the mandated SLR, can be used for computing LCR.

The RBI has now allowed government securities up to another 2 per cent of NDTL under FALLCR to be taken into account for LCR. Essentially, banks can dip into government bonds under mandated SLR to the extent of 15 per cent of NDTL for meeting LCR requirements.

What this implies is that 2 per cent of NDTL, which works out to about ₹2.5 lakh crore, has the potential to get released into the system.

Banks can borrow funds against these bonds to meet the liquidity requirement of other players such as NBFCs.

However, the actual amount released into the system will depend on a number of factors.

One, each bank would be faced with different liquidity conditions, and hence, the ability to release funds into the system will vary from one bank to another. The RBI’s move would, however, help meet inter-bank liquidity requirements. Two, banks can only borrow up to 1 per cent of the NDTL at the repo rate of 6.5 per cent.

The balance requirement of funds will have to be raised at the MSF window, which comes at a higher rate of 6.75 per cent.

Hence, banks may or may not be urged to borrow at a higher rate based on how efficiently they are able to deploy these funds.

Three, the RBI’s measure may not altogether address the liquidity crunch of NBFCs, given that some banks may be wary of the sector.

That said, the RBI’s assurance of offering adequate liquidity, will help soothe the market and ease short-term rates.

However, the key will be to ensure durable liquidity through OMOs in the coming months.

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