Liquidity war holds up rate cut by banks

  • Reuters
  • Updated: May 26, 2016 06:06 IST

The Reserve Bank of India (RBI) has stepped up fund injections in the two months since governor Raghuram Rajan pledged to gradually erase a cash deficit in the financial system, but commercial banks say it is still not enough for them to sharply lower interest rates.

The RBI has slashed rates by 150 basis points (bps) since the start of last year, bringing the policy rate to a five-year low of 6.50%, but the country’s banks have cut lending rates by less than half that.

Bankers say that there is not enough liquidity in the market for them to lower rates and lend more freely while still being sure they can fulfil their liquidity requirements.

Including Wednesday’s ongoing auction, RBI has pumped in over Rs 60,000 crore into the market. “That is enough liquidity for banks to lower rates,” RBI officials said.

But bankers say India continues to have a daily core liquidity deficit of around Rs 1 lakh crore.

These cash shortages increase banks’ funding costs, making it harder for them to lower lending rates, according to bankers, who say they plan to press the issue with the RBI.

Yet the central bank fears injecting too much money would spark inflation. The amount of currency in circulation has surged since October, largely due to spending in recent state elections. And cash withdrawals from banks hit ` 17.5 lakh crore in the week ended May 13, the biggest weekly total in 15 years.

The RBI says the this money will at some point make it back into the financial system and that more cash injections now could result in excess liquidity.

Bankers believe RBI can remove any excess liquidity via open market operations (OMO), something the RBI has been reluctant to do due to fears it would make inflation volatile

“The governor said ‘we will provide liquidity’ and OMOs are going on” said an RBI official. “Should blame come to the banks or the RBI?”

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