BW Explains: Banks Flag High Overnight Rates, What Does It Mean For Consumers?
Banks have raised concerns with the Reserve Bank of India (RBI) regarding consistently high overnight rates and liquidity conditions. They seek more equitable access to funding and aim to reduce the widening gap between benchmark policy rates and overnight rates.
What is the whole scenario? BW Explains the high overnight rates and what it holds for consumers.
What is the Overnight Rate?
The overnight rate is the rate at which banks lend funds to other banks at the end of the day in the overnight market, the goal being to maintain the mandated reserve requirements set by the central bank, keeping the banking system stable and liquid. When a bank cannot meet its reserve requirement, it borrows from a bank that has a surplus reserve.
The story so far
Discussions among lenders and other participants in money markets have highlighted the evolving nature of liquidity distribution in the banking system. Some entities are only able to access funds at elevated rates, prompting requests from self-regulated market institutions for the RBI to intervene and bring overnight rates closer to the benchmark policy repo rate. A source with knowledge on the matter stated that according to banks, one cannot get a true representation of the liquidity surplus by just looking at the extra funds kept with the RBI.
24x7 banking has contributed to the rise in call rates, as it has resulted in banks storing cash at the RBI's Standing Deposit Facility (SDF), meaning that when banks short of cash go to the call market, the rates are generally higher. The call money market serves as a platform for lenders to fulfil their overnight financing requirements.
The Weighted Average Call Rate (WACR) has exceeded the benchmark policy repo rate by approximately 25 basis points for about a month. Currently standing at 6.50 per cent, the repo rate has caused a rise in other market benchmarks such as the Mumbai Interbank Outright Rate (MIBOR) and tri-party repos.
On Tuesday, the WACR closed at 6.78 per cent. The WACR is the operating target of the RBI's monetary policy. According to another source, the liquidity framework published in 2020 includes measures for adjusting repo operations by the RBI to maintain market rates close to the policy rate. They also expressed concern with the consistent high overnight rates for the past month.
Since March, the RBI has not announced variable rate repo operations, through such operations, the central bank injects liquidity into the banking system.
The impact on consumers
Overnight rates are a good indicator of short-term interest rate movements in the broader economy and lead to a domino effect on various economic indicators such as employment and inflation.
With increased overnight rates, it becomes costlier for consumers to borrow money, as the augmented expense incurred by banks is transferred to the consumer.
