Liquidity problem may resurface

With a slew of measures - a CRR cut of 250 basis points over less than 10 days, a 14-day repo window to enable banks to borrow up to 0.5 per cent of deposits parked with the central bank as securities by way of statutory obligation, and immediate release of funds under the farm debt waiver scheme, et all – around Rs 1,30,000 crore has been infused into the system. The liquidity crunch has been overcome for now.

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But, with the busy season ahead, the fear is that the problem may again raise its ugly head.

The bank credit to commercial sector is up by as much as 25 per cent on a year-on-year basis as of September 26, 2008 – well above the projected 20 per cent for the fiscal – and is expected to rise during the second half.

This, along with the rate of deposit mobilisation lagging behind at 19.8 per cent, can make the liquidity situation graver.

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Judging by the manner in which banks are vying with one another to jack up deposit rates and quoting as high as 12 per cent for certificates of deposits for tenures ranging from three months to one year, the banking system is bracing for the worst on this score.

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Indeed, the contours of this crisis were already taking shape as the current fiscal began. The demand for credit was brisk while deposit mobilisation had lagged behind.

At the end of the first quarter, while deposits rose by 21 per cent on a year-on-year basis, advances were up by 26 per cent. By the end of the first half, credit growth has surpassed the rate of deposit accretion by the same margin – 25 per cent as against 20 per cent.

Banks pared down their excess SLR holdings to augment their lendable funds. The investment-deposit ratio, which stood at 30.47 per cent as of March 28, 2008, fell to 28.68 per cent by September 26, 2008.

On an incremental basis, the credit-deposit ratio rose from 66.1 per cent in the first quarter to 77.2 per cent in the second quarter of FY09 while the investment-deposit ratio retreated from 20.5 per cent to -0.4 per cent.

In other words, banks pruned their investment portfolio and the excess SLR holdings came sharply down between these quarters.

For the first half, the incremental credit-deposit ratio was impressive at 73.6 per cent but the incremental investment-deposit ratio was rather low at 6.3 per cent, the comparable figure at the end of September 2007 being 44.9 per cent.

Besides, direct lending, banks were also proactive in investments in bonds and shares so much so, that the total accommodation to the commercial sector has increased by 25 per cent to Rs 25,92,054 crore as of September 26, 2008.

Deposit growth during the mid year was 19.8 per cent, higher than the anticipated 17 per cent for the year but trailed far behind the rate of increase in commercial lending.

Traditionally, during the second half of the year, both lending and deposits record a faster growth than during the preceding half. It is therefore on the cards that the crisis on the liquidity front may get worse and ad-hoc responses may not be very effective in coping with this issue.

A new approach may be needed, in particular, in regard to the statutory liquidity ratio, which has been pegged at 25 per cent for almost eleven years now. The moot question is, how will the central bank address this issue in the credit policy review which is only days away?

Will it effect a cut in the statutory liquidity ratio also either separately or in tandem with a lowering of the cash reserve ratio?

With the Banking Regulation (Amendment) Act, 2007 in force, the floor of 25 per cent is no longer sacrosanct. Moreover, with banks facing a shortage of repoable securities to be used a collateral for borrowing under the repo window – the poor response to the 14-day repo facility for the purchase of securities worth Rs 20,000 crore can be partly attributed to this – RBI may have to do some rethinking. A lower SLR of say 23 per cent and also expanding the scope of eligible securities under this head are among the options before it.

Already, the SLR of 25 per cent has been breached – de facto if not de jure – in that borrowing of up to 0.5 per cent of holdings has been now allowed.

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If this is formalised and SLR cut by 200 basis points, the liquidity situation stands to improve considerably. With special securities and triple-rated bonds of public sector undertakings given SLR status, banks will greater leeway in tapping the repo window for funds.

As regards the interest rates, the credit policy review may opt for the status quo. No change in repo rates is likely, with inflation still perched at a high level.

Banks too, are busy tapping deposits at stiff rates and as such may be averse to any softening in the rate on advances.

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