Overnight borrowing costs rose on Monday after the Reserve Bank of India (RBI) moved to absorb excess funds from the banking system, with experts saying the steps could help banks pass on policy rate hikes more effectively.
The weighted average call money rate climbed to 5.43 per cent from 5.31 per cent on October 9, according to Clearing Corporation of India (CCIL) data. The increase followed the central bank’s decision to raise the minimum daily Cash Reserve Ratio (CRR) maintenance requirement to 99 per cent from 90 per cent and announce open market operation (OMO) sales of government securities.
High surplus liquidity can weaken the transmission of monetary policy by reducing banks’ dependence on market borrowings and allowing them to meet credit demand using readily available funds, money market experts said.
When banks have ample funds, they face less pressure to raise deposit rates to attract money. This can delay increases in lending rates for borrowers. Excess liquidity can also keep short-term money market rates low, limiting the immediate impact of a policy rate hike on overall borrowing costs.
Consequently, monetary tightening may take longer to feed through to bank lending rates and broader economic activity.
“Rate hikes amid an extreme liquidity surplus can weaken monetary policy transmission. Hence, it was essential for the RBI to absorb surplus liquidity and bring overnight rates closer to, or even above, the repo rate to ensure effective transmission of its policy stance by taking measures like increasing daily CRR maintenance and OMO sales,” said Mataprasad Pandey, vice-president at Choice Wealth.
In a note, economists at State Bank of India (SBI), the country’s largest lender, said the higher daily CRR maintenance requirement would reduce banks’ flexibility in managing funds. They noted that banks had generally maintained CRR balances above 95 per cent of the prescribed requirement.
“Overall, it tightens liquidity without raising the CRR, which suits the current phase of rupee support too and the MPC stance,” the note said, referring to the Monetary Policy Committee (MPC).
Last week, the RBI announced a series of measures to manage liquidity and foreign exchange, including a higher minimum daily maintenance requirement for the CRR and open market operation sales of government securities.
The central bank raised the minimum daily CRR maintenance requirement to 99 per cent from 90 per cent. It also announced an auction to sell government securities worth Rs 25,000 crore on October 13.
The measures are aimed at absorbing a large surplus in the banking system, which built up following substantial inflows of deposits under the Foreign Currency Non-Resident (Bank) scheme, known as FCNR(B).
The RBI has also been conducting variable rate reverse repo (VRRR) auctions to absorb surplus funds and bring overnight money market rates closer to the repo rate.
At a post-monetary policy press conference on October 6, RBI Governor Sanjay Malhotra said the substantial liquidity in the banking system would be absorbed within the current financial year through several channels, including currency leakage, the central bank’s liquidity operations and banks’ reserve requirements.