On Saturday evening RBI announced that banks will need to maintain a 100% CRR on deposits received between 26th Sept and 11th November. This will suck out around Rs 3 Lakh Cr from the banking system. It is important to understand the reason why they did this and how it was essential to maintain Financial Stability a key tenet of RBI’s function in the economy.
Now after the announcement of Demonetization banks have been flooded by huge deposits. The outflow has been much lesser due to a variety of reasons the key being the limit on weekly withdrawals as well as lower availability of new currency notes. Now banks have already got Rs 8 Lakh Cr of deposits. As per regulations once this money is deposited with the banks they have to put 4% aside as CRR with RBI, use around 21% to buy government bonds as part of SLR requirements (a route the government has made to fund its deficits relatively cheaply) and the rest of the money can be used for lending purposes. The ground situation today is that lending activities have gone down as people and companies grapple with Demonetization, deposit flow is huge and withdrawals are lagging deposits.
This has created a peculiar situation where the banks are forced to buy Government Securities as they need to put 21% aside to do that every day (broadly). This is pushing down yields to unrealistic levels and giving an easy exit to FII’s as well as other investors who know that this move might be unsustainable at a time when global bond yields are actually rising. Now the other thing that is happening is that as lending is muted the banks are approaching the RBI to deploy the money with them under reverse repo. Now when reverse repo happens banks give the money to RBI and they get 5.75% on that money and as security the RBI gives the banks the Government Bonds that it holds. Due to the deluge of reverse repo with RBI it actually ran out of its holdings of Government Securities that it could give to the banks on Friday.
What the current move of RBI does is that it takes out Rs 3 Lakh Cr from the banks. Yes they will lose out around Rs 700 Cr over a 2 week period in interest. However the fact is that they would have lost much more if they were continuously forced to buy government securities at lower and lower yields to maintain SLR and when the reversal in deposits would start they would stare at huge losses. The total deposits with banks today are at around Rs 100 Lakh Cr. Assuming a current SLR of the banks at around Rs 25 Lakh Crores even a 2% loss on this holding is Rs 50000 Crores. As such it is better to take some interest loss now than have huge capital losses when deposits are withdrawn from the next quarter.
Many analysts and traders will shout that this is a negative move for banks. It is only negative for traders, for investors this is the right move as it maintains Financial Stability in the economy.
