Indian Banks Demand Easing Liquidity Conditions On Overnight Cash Rate

Indian banks are urging the Reserve Bank of India (RBI) to ease liquidity conditions in the banking system, as overnight cash rates have exceeded the key policy rate for more than five months. Treasury officials have made these suggestions to the RBI before a policy meeting next month. 

The banks hope that with inflation expected to ease, the central bank will loosen liquidity and possibly move it into a surplus as high rates are hurting them. These suggestions were made to the Fixed Income Money Market and Derivatives Association of India (FIMMDA) by banks on Wednesday.

In mid-2023, the Reserve Bank of India (RBI) implemented measures to control inflationary pressures caused by an excess of cash in banks due to the withdrawal of Rs 2,000 currency notes. 

To counteract inflation and reverse the pandemic-era stimulus, the central bank's rate-setting panel had already increased the benchmark policy rate by 250 basis points (bps) between May 2022 and February 2023, bringing it to 6.50 per cent. 

Currently, India's banking system liquidity deficit stands at around Rs 2 trillion (USD 24 billion), leading to the weighted average interbank lending rate reaching close to 6.75 per cent.

Due to tightened liquidity, the Reserve Bank of India (RBI) has stopped withdrawing cash from the banking system through variable-rate reverse repos (VRRR). Instead, it now lends cash to banks through intermittent auctions, like the three-day, Rs 500 billion variable rate repo on Friday. 

Treasury officials believe that the quantum and frequency of these repos will be increased in the future.  According to a senior treasury official at a state-run bank, there is a shortage of durable liquidity in the market, and the RBI will need to conduct variable rate repos regularly to address this. 

The official also believes that the 14-day VRR will be the preferred liquidity infusion tool for the RBI in this quarter. The next policy decision by the RBI rate-setting panel is scheduled for 8 February 2024.