Banks Ask RBI To Move To Overnight Liquidity Management

Indian banks have urged the Reserve Bank of India (RBI) to move away from its existing 14-day variable rate repo system to an overnight liquidity management instrument, as they feel a more dynamic system is needed in an age of 24-hour banking, as reported by Reuters. They have also suggested taking up a new benchmark for overnight rates to improve monetary policy efficiency, five sources with knowledge of the talks conveyed this to Reuters.

The RBI launched the 14-day variable rate repo in 2020 to decrease banks' reliance on the central bank and promote improved liquidity forecasting. In this system, the RBI injects cash into the banking system through repos and absorbs surplus liquidity through reverse repos. But with changing banking operations and liquidity requirements, lenders contend that a daily liquidity management instrument would be more effective.

According to the article published by Reuters, the issue was discussed during a recent meeting between the RBI and certain market players before the central bank's first monetary policy announcement of the financial year, due on April 9.

Besides liquidity instruments, financiers have also recommended that RBI reconsider the cash reserve ratio (CRR) and cut it further to further relax liquidity issues. Banks have also requested an end to the weighted average call rate (WACR) and a shift to a fresh benchmark rate that will better support monetary policy formation.

WACR is the average interest rate at which banks borrow and lend money to each other for just one day. It shows how easy or expensive it is for banks to get short-term funds. The Reserve Bank of India (RBI) watches this rate to understand money flow in the banking system.

In December, the RBI suggested launching the Secured Overnight Rupee Rate (SORR) as an alternate benchmark overnight rate.

SORR is also an overnight borrowing rate but with a key difference—it is secured. This means banks provide government bonds as security when borrowing money. Because of this, SORR is usually more stable than WACR.

Banks have now seconded this suggestion, proposing that SORR take over from WACR as the monetary policy operating target.

In the meantime, the central bank has added around 6.4 trillion rupees (75.05 billion dollars) of long-lasting liquidity to the banking system since December and will make open market purchases worth another 600 billion rupees this month. The injection of liquidity is meant to stabilise short-term funding conditions and enhance monetary transmission.

Reuters last week said that the RBI could revive a system of giving banks a fixed quantum of on-tap overnight liquidity. The short-term measure was earlier utilised to remove a cash shortage and was viewed as pivotal in facilitating improved monetary policy transmission.

The pressure for a transition to an overnight liquidity tool also stems from wider issues regarding liquidity mismatches in the banking system. Daily access to funds could help banks better manage their cash flows and reduce their reliance on longer-term central bank liquidity injections, as financial markets become more open and 24-hour banking becomes the new norm.

The central bank's monetary policy goals, inflationary pressures, and general economic conditions will probably influence how the RBI responds to these suggestions. Money markets, lending rates, and overall financial stability will all be impacted by any prospective switch to a new benchmark rate or overnight liquidity management system.

As the monetary policy review is around the corner, all eyes will now be on how the RBI treats these proposals and whether it inched closer towards a more responsive and flexible liquidity management system.