Move to ease liquidity through cuts in reserve ratio


By

Deepak Bansal
Asst. Professor / Controller of Examinations
JIMS Engineering Management Technical Campus
Greater Noida
 


The Reserve Bank of India's move to ease liquidity through recent cuts in cash reserve ratio may help banks with adequate liquidity to improve profitability in the fourth quarter ended march, 2012. It's purely a liquidity-easing measure. Banks may not rush to cut lending and deposits rates due to year-end considerations. But a cut in policy rates and easing of liquidity could prompt banks to cut rates. A 75bps CRR cut by the RBI is more than a liquidity easing measure. The market was expecting a 50bps CRR cut in the RBI policy review on the 15th of March and the fact that the RBI cut CRR by 75bps can be taken as a central bank indicating a full shift in its monetary stance. Tight liquidity conditions have provided an opportunity for the RBI to indicate its shift in stance from inflation control to spurring growth.

The CRR cut will help banks improve net interest margins by 12-15 bps. The previous CRR cut of 50 bps in January will add another 5-6 bps to NIM. The impact of the latest CRR cut may not be felt immediately as cost of funds has shot up more than 20 bps in January-March.

This cut in the Cash Reserve Ratio by the reserve bank of India is expected to inject Rs 48,000 crore of liquidity into the banking system. The move was aimed at enabling banks to tide over the possibility of an acute liquidity shortage due to the corporate advance tax outflow, estimated at around Rs 60,000 crore.

The effect of the CRR cut will initially be felt more in the equity markets than the bond markets. Bank stocks are likely to rally on account of improved sentiments on the CRR cut. The Bank Nifty, which has rallied by 30% calendar year to date will see further upside as the CRR cut comes on the back of improved sentiments over the Greek debt swap deal and on better than expected employment data in the US. Greece concluded its debt swap with private bondholders while the US added 270,000 jobs in February 2012 against market expectations of 210,000 jobs.

The change in CRR gives them a much large cushion when it comes to accessing the repo window. When the deficit is around Rs 1.3 lakh crore a day, some banks are pushing against their holdings of SLR securities.

The system as a whole is quite liquid in that sense. But day-to-day reliance on repo, although it means there is no liquidity crunch as such. The CRR cut offers a little more comfort, a little more permanent change in the cash position. It frees up resources and makes credit planning a little more easier and allows for banks to think in terms of longer-term credit commitments.

The liquidity deficit in the banking system continues to remain above the central bank's comfort level, despite a 75-basis point cut in the cash reserve ratio (CRR), which came into effect on Monday. Banks on Monday borrowed Rs 1.3 lakh crore from the reserve bank of India's repo window. This was more than double RBI's comfort level, which is +/- 1 per cent of net demand and time liabilities, or Rs 60,000 crore.


                                
Source: Bloomberg

Market participants say the liquidity deficit may continue through March, as banks would need resources to meet quarterly targets. The situation is expected to improve in April. The government usually spends a large amount in the beginning of April, making its balances with RBI negative. With this seasonality in place, it is likely the government would record negative balances of Rs 40,000 crore in April, which effectively means average LAF (liquidity adjustment facility) borrowing would be around Rs 30,000 crore to Rs 40,000 crore, assuming no forex intervention.

Banks' demand for cash also made short-term rates sticky, with rates on three-month certificates of deposit (CDs) at around 11 per cent. According to dealers, while Allahabad Bank raised three-month CDs at 11.10 per cent, ING Vysya Bank raised these at 11.44 per cent. The lack of appetite among investors also led to the rates staying high, said dealers.

References:

The Economic times, New Delhi
Business standard
The Times of India
The Hindu
Bloomberg
 


Deepak Bansal
Asst. Professor / Controller of Examinations
JIMS Engineering Management Technical Campus
Greater Noida
 

Source: E-mail March 13, 2012

          

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