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All you wanted to know about LTRO

Keerthi Sanagasetti | Updated on February 25, 2020 Published on February 25, 2020

When you’re trying to solve a problem, it helps to take inspiration from your peers. The Reserve Bank of India, too, is not averse to taking cues from other central banks in developed countries to come up with ideas to stimulate the economy during the slowdown. First, it took a leaf out of the US Fed’s book and carried out ‘Operation Twist’, to quell rising rates. Now it is hoping to roll out long-term repo operations (LTROs), taking cues from the European Central Bank. On February 6, the RBI announced the infusion of ₹1 lakh crore into the system in phases, through the LTRO.

What is it?

The LTRO is a tool under which the central bank provides one-year to three-year money to banks at the prevailing repo rate, accepting government securities with matching or higher tenure as the collateral.

While the RBI’s current windows of liquidity adjustment facility (LAF) and marginal standing facility (MSF) offer banks money for their immediate needs ranging from 1-28 days, the LTRO supplies them with liquidity for their 1- to 3-year needs. LTRO operations are intended to prevent short-term interest rates in the market from drifting a long way away from the policy rate, which is the repo rate.

Why is it important?

Ever since the economic slowdown hit India and the IL&FS fiasco triggered a spike in borrowing costs, the RBI has been trying to stimulate the economy through easy-money policies. Since January 2019, the repo rate (the rate at which banks borrows quick money from RBI) has been cut by 139 basis points. But only a part of these rate cuts have as yet been passed on to borrowers by banks and other lenders.

When charged with this slow transmission of rate cuts, bankers complained that repo loans constituted only a miniscule portion of their overall funds, making it difficult for them to cut lending rates. Under the LAF, banks could only bid up to a maximum of 0.75 per cent of their net demand and time liabilities.

The LTRO bidding system, taken with the removal of the 0.75 per cent limit on LAF borrowings, is expected to remove these constraints. The RBI believes that offering banks durable longer-term liquidity at the repo rate (5.15 per cent), can help them lower the rates they charge on retail and industrial loans, while maintaining their margins. The encouraging response to the first auction indicates the banks’ high appetite for cheap funds — bids were received for more than 7.7 times the amount auctioned (₹25,000 crore). The LTRO will also help bring down the yields for shorter-term securities (in the 1-3-year tenor) in the bond market.

Why should I care?

If you are a millennial, accusations from officials about your lifestyle choices leading to a consumption slowdown in the country must have left you perplexed. After all, the interest rates on your consumer and personal loans didn’t change much despite the Monetary Policy Committee continuously trimming repo rates. The recent pause in repo rate cuts, too, may have brought you much anguish, given that it signals that rates may not dip further from hereon, despite the slowdown.

To put an end to all this, the RBI seems to have shifted its focus from trimming rates to the transmission of older rate cuts to the actual borrowers in the economy. The LTRO is a move in that direction. With an increase in the proportion of low-cost funds, banks may now be forced to bring down interest rates on loans. This may also mean lower deposit rates for savers.

The bottomline

It’s no longer about just the repo and open market operations; the RBI is adding new tools to its armoury.

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Published on February 25, 2020
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