Water-Water Everywhere, Not a Drop to Drink....
Well yes, the Indian Banking System's current liquidity position, amidst the unfortunate COVID-19 outbreak in our country, compares very well with that of an Ocean which has an abundance of water in its kitty, but still, this water is not drinkable, and so is of no use to quench the thirst of the people.
As of now, the Banks are sitting on a huge fund base of Rs. 6.9 lakh crore, the amount being absorbed by them under the reverse ratio operations. However, the Banks have been parking excess liquidity under the liquidity adjustment facility (LAF) window, with the Reserve Bank of India (RBI), instead of lending this huge fund base to the liquidity deprived socio-economic sectors, amidst this unprecedented and prolonged lock-down period, caused due to coronavirus pandemic.
1. Remedial Measures Announced by the RBI on 17.4.2020
In order to address the above paradox, and to maintain adequate liquidity in the socio-economic system and its constituents, in the face of COVID-19 related dislocations, and to ease out financial stress of small and medium-sized sectors and entities, the RBI's Hon'ble Governor, Sh. Shakti Kant Das has announced a host of Relief and Remedial Measures as under:
a. Reduction in Reverse Repo Rate
The RBI had cut reverse repo rate by 90 basis points to 4% on 27th March 2020. On 17.4.2020, the RBI had further reduced the reverse repo rate by 25 basis points to 3.75%.
Reverse repo rate is the rate of interest, at which the commercial banks lend their surplus money/funds to the RBI.
A decrease in reverse repo rate means that commercial banks will get less interest/incentives to park their funds with the RBI, thereby motivating them to lend more money to the borrowers.
Repo rate is the rate at which the Banks borrow from the RBI, and this rate has been kept intact at 4.4% on 17.4.2020.
So, the difference between the rate of borrowing and lending by commercial banks from the RBI is now 65 basis points.
Banks are borrowing at an interest rate of 4.4% from the RBI and have the option to lend at a multiplier rate ranging from 8% to 14%. That is the incentive given by the RBI to increase the money supply in the economy.
However, due to the recent Banking/NBFC systemic failures like that of YES Bank, IL&FS, Dewan Housing Finance Corporation Ltd, PNB-Mehul Choksy-Nirav Modi fiasco, to name a few, the Banks tend to behave in an over-cautious and a knee-jerk reactive manner now, with the tendency of static decision making concerning lending of loans and advances to the needy and deserving borrowers.
This extra cautious approach of the Banks in lending money is resulting in the worsening of the liquidity crisis for the cash deprived needy borrowers mostly MSMEs.
However, it is expected and desirable, that as a result of this pro-active initiative of the RBI in reducing the reverse repo rate by 115 basis points over a very short period of time, the Banks will be more willing and encouraged to lend their surplus funds to the needy and deserving borrowers, as they have to take the plunge of either to lose 65 basis points if they park their surplus funds with the RBI or to stand to gain almost 10 percentage points in interest, if they lend.
b. Targeted Long-Term Repo Operations (TLTRO)
A further disturbing phenomenon, which is being seen and observed currently, is the tendency of the Banks to lend money only to big corporate players, who are already cash rich and their hesitation and shyness in lending money to the needy and liquidity deprived MSMEs and lower strata of the economical pyramid.
The first round of liquidity infusion of Rs. 1 trillion being injected into the banking system, by the RBI, through Targeted Long Term Repo Operations (TLTRO 1.0), has not produced the desired results as the money has not found its way to the liquidity constrained sectors and small and medium sized entities/MSMEs and instead has gone into the pockets of big corporate entities and PSUs, who were already enjoying robust liquidity.
On 17.4.2020, the RBI has put another Rs. 50,000 crore as part of TLTRO 2.0. However, learning from the experience of TLTRO 1.0, an additional condition has been imposed by the RBI, wherein, the Banks can only get this money if they lend to NBFCs and Micro Finance Institutions (MFIs).
TLTROs are sector specific relief measures of the RBI, in the form of mid-term loans, to ensure adequate liquidity at the longer end of the yield curve to sectors and entities which are experiencing liquidity constraints and/or hindrances to market access.
c. Refinancing Facilities to AIFIs
In view of the tightening of financial conditions in the wake of the COVID-19 pandemic, another Rs. 50,000 is to be provided as refinance facility to the three All India Financial Institutions (AIFIs), i.e. the NABARD, SIDBI and NHB, to facilitate and encourage smooth and seamless flow of credit to the small-scale firms, rural sector, housing finance firms, NBFCs and MFIs. Again, this should help in money reaching the last mile.
d. Easing of Asset Classification Norms
On March 27, 2020, the RBI had permitted the Banks & Lending Institutions to grant a moratorium period of three months to the borrowers on payment of their current dues falling between March 1 and May 31, 2020.
The hon'ble RBI Governor on 17.4.2020 has further announced an easing of asset classification norms for all accounts where moratorium or deferment has been applied. This essentially means that in respect of all such accounts, where moratorium or deferment of three months, has been applied, and which were standard as on 1.3.2020, the 90-day NPA norm shall exclude the moratorium period, and there will be an asset classification standstill on all loans covered under the moratorium from 1 March to 31 May 2020.
However, banks will have to maintain additional 10% provisioning on these standstill accounts over two quarters of March 2020 and June 2020, which may put pressure on their balance sheets. These provisions can be adjusted later on against the provisioning requirements for actual slippages in such accounts.
e. Extension of Resolution Timeline
Under RBI's prudential framework of resolution of stressed assets dated June 7, 2019, in the case of large accounts under default, Scheduled Commercial Banks, AIFIs, NBFC-ND-SIs and NBFC-D are currently required to hold an additional provision of 20 per cent if a resolution plan has not been implemented within 210 days from the date of such default.
Considering and recognising the practical challenges to the resolution of stressed assets in the current COVID-19 driven environment, the RBI on 17.4.2020, has announced that the period for resolution plan shall be extended by 90 days.
f. Reduction in Liquidity Coverage Ratio
The central bank has also lowered the Liquidity Coverage Ratio (LCR) requirement for banks to 80% from the existing 100%, with immediate effect. This will be gradually restored in two phases – 90% by 1st October, 2020 and 100% by 1st April, 2021. LCR is the proportion of high liquid assets that banks have to keep, to meet their short-term liabilities.
g. No Dividend Pay-outs by Banks & Co-operative Banks
In order to ensure that the Banks conserve their capital to support adequate credit flows and to absorb losses in an environment of increased uncertainty. Accordingly the scheduled commercial banks and co-operative banks shall not make any further dividend pay-outs from their profits pertaining to the FY 2019-20, until further instructions. This restriction shall be reviewed on the basis of the financial position of banks for the quarter ending 30.9.2020.
h. NBFC Loans to Commercial Real Estate Projects
The RBI has also allowed for extension of date for commencement for commercial operations (DCCO), in respect of loans given by banks and NBFCs to commercial real estate projects, delayed for reasons beyond the control of promoters, by an additional one year, over and above, the one-year extension permitted in normal course. This extension will not be treated as restructuring.
2. Concluding Remarks
The above discussed monetary policy decisions and relief measures being announced by the hon'ble RBI Governor, on 17.4.2020, are indeed a welcome and much needed initiative of the apex Banking Body- the RBI, in facilitating adequate liquidity in the socio-economic system and its constituents, in the face of COVID-19 related dislocations, and to ease out financial stress of small and medium sized sectors and entities.
However, these policy decision initiatives and relief measures being announced by the RBI, will result in their desired and expected outcomes and bear fruitful results only if the implementing agencies viz. the Banks and Lending Institutions will actually start doing their business of lending finances to the liquidity constrained sectors and MSMEs entities, and not merely parking their surplus funds with the RBI, or investing in bonds and instruments of big PSUs.
Then only the currently worsening financial position and the liquidity crunch in the economy will ease out and the liquidity constrained sectors and MSMEs will get the requisite nourishment and resilience to reverse the current slow-down and return to high growth trajectory, as estimated by the IMF, and reinstated by the RBI.
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