Simplified Operations for Statutory liquidity management: Time to review!

Cumbersome operational procedures leading to inefficiencies

Banks need to maintain statutory obligation out of the Net Demand and Time Liabilities (NDTL). To this effect, 25.5% of NDTL is taken away from the system in two ways: 21.5% SLR invested in interest bearing Government bonds (Central, State  and other approved securities) and 4% CRR in zero yield Current Account balance with RBI. This means that 25.5% Bank's sources of funds are impounded by the RBI. The rationale for this is attributed to dilute systemic risk (as fall back when in distress), to feed Government fiscal deficit, to cut financial intermediation leverage and ensure protection of public interest who invest in Bank's liability products. There is need to review the high level of impound against significant improvement in financial strength of Bank's balance sheet, fiscal prudence leading to lower dependency on Bank's participation (and emergence of non-bank investors) and adjusting the leverage to higher risk capital (upward revision of CAR from current 9% to over 12%) than over 25% of cash impound. There is also no merit in giving valuation shield on SLR investments through HTM protection over the mandatory requirement (current at 24% against 21.5% of SLR, seen as comfort to stay in risk-off Gilts than lending to risk-on credit). There is need to cut the level of cash impound (from 25.5% to below 20%), and reduction of HTM limit to below SLR limit!

There is also need to provide fungibility between SLR and CRR to simplify the operations involved in Bank's Treasury. The exercise of maintaining 4% of NDTL (on a fortnightly average basis with daily cap and floor) in Current Account with RBI is not an easy task against volatile net clearing differences. It is more difficult when large value lumpy money transfers are made through net banking without any information to the Bank. While the efficiencies built on Transaction Banking platform (to the delight of customers) can't be diluted, it is possible to make things easy for Banks through review of existing rules and procedures. Banks fund the deficit in Current Account through refinance of its excess SLR (at Repo or CBLO counter) or borrowing from Call Money market or swap of foreign currency sources in the cash/tom market. Needless to say, this process leads to huge transaction flows which are mostly repetitive on daily basis; Call Money lending/borrowing, Repo/CBLO borrowing and FX swaps are rolled over mostly with same counter parties, thus increasing the operating cost and risk!

Is fungibility between SLR and CRR a better option?

Step 1:

Banks should have the flexibility to maintain the Current Account with RBI at 0-4% of CRR requirement, meeting the shortfall from SLR portfolio. On the other side, any short fall in SLR can be met out of higher CRR (in the event of removal of HTM comfort to Banks). It means that Banks need to maintain the statutory requirement of 25.5% in aggregate of approved SLR securities and cash balance in the Current Accounts with RBI. There can be a minimum limit on each category to avoid excessive play, say minimum 2% in CRR (against the mandatory 4%) and minimum 18% in SLR (against the mandatory 21.5%).

Step 2:

RBI will charge interest on shortfall in CRR at Repo rate, and pay short fall in SLR at discount to Reverse Repo rate to compensate for the zero yield on excess CRR Current Account balance maintained to cover short fall in SLR.

Benefits:

It will drastically reduce the overnight transactions in Call money, CBLO, Repo and FX markets, thus reducing the load on technology platforms across CCIL and RTGS platforms. There will not be any settlement disputes between counterparts in the event of non execution of transactions due to human error and/or systems & technology failure. It will also bring in price-stability, cutting the volatility from last minute, lumpy demand or supply of funds.

Just thinking aloud into the ears of Raghuram Rajan (and commercial banks) to put mind to these critical operations to bring in cost efficiency and cut operational risks. To start with CRR fungibility within 2-4% will mean 2% CRR cut, when Banks hold huge excess SLR funded by NDTL.

If this is done, Government Bond yields will ease without cutting policy rates for effective (and efficient) transmission on lending rates.

Moses Harding