RBI today announced four liquidity measures and four regulatory changes intended to help the Covid-19 hit economy, along with a prudential regulation barring dividend payments by banks till further notice: banks have to build up their capital buffers against bad loans that could pile up.You can take a horse to water, but you cannot make it drink. This is an old saying, so old that people who have not touched a horse in their real life, leave alone tried to make it drink water, constitute the vast majority of humanity, particularly that elite chunk of it that inhabits the Reserve Bank of India. Perhaps this explains why RBI honchos keep at their equine exertion with nary a lick’s worth of dip in the water level in the trough.
The RBI today announced four liquidity measures and four regulatory changes intended to help the Covid-19 hit economy, along with a prudential regulation barring dividend payments by banks till further notice: banks have to build up their capital buffers against bad loans that could pile up.
All the regulatory measures are welcome and will help companies and real estate developers. The liquidity measures are a mixed bag.
The cut in the reverse repo rate is effective admission that the earlier measure of making yet more liquidity available to the banks via its long-term repo operations (LTROs) and Targeted LTROs (TLTROs) have not been working. For those mystified by RBI jargon, a repo is a sale and repurchase operation. A bank sells a bond at a particular price to the RBI, gets cash in return, agreeing to repurchase the bond back at a higher price after a specific period. That difference in price over the time period in question — overnight, fortnight, three years — works out as a rate of interest. Reverse repo is when the RBI sells the bond to the bank, taking money from the bank, with assured repurchase at a higher price. Through reverse repo, the RBI takes in money from banks and gives them an assured rate of return. This is totally risk-free return and the lower it is, the greater the incentive for banks to lend their money to someone who will pay a higher rate of interest.
Banks have simply been putting money back with the RBI. On March 27, the RBI governor informed us that banks were putting money back into the RBI at a daily rate of Rs 2.86 lakh crore, instead of using the liquidity to make fresh loans to business. Between March 27 and April 14, the funds the banks have been putting back into the RBI has gone up to Rs 4.36 lakh crore a day. On April 15, this amount spiked to Rs 6.9 lakh crore. The RBI now hopes that lowering the return on the money parked with it via reverse repo will persuade banks to lend to industry and business. This is futile.
No one is going to start an investigation into why a bank chairman and managing director deployed money with the RBI, whereas lending to a company runs two risks: one, of the loan turning bad, and two, of some promotion-hungry busybody or someone with the knives out for you raising a quiet complaint about a kickback and the CBI starting an investigation into the banker’s motive for granting that loan, with the Enforcement Directorate chipping in with a moneylaundering charge. Public sector bank managers have no incentive to lend — their remuneration structure offers little incentive for performance — and lots of incentives for playing it safe. This must change, before pushing money to the banks works out as an effective way of pushing money to economic agents.
The second TLTRO, planned for Rs 50,000 crore, seeks to push money to non-banking finance companies (NBFCs). This is welcome. Especially as 50% of it is to go to the bonds issued by smaller NBFCs and microfinance institutions. These bodies know how to lend to small industry, and this step is bound to put liquidity in the hands of small and medium business more surely than the initial TLTRO.
The third measure of granting refinance worth Rs 50,000 crore to National Bank for Agriculture and Rural Development, Small Industries Development Bank of India and the National Housing Bank is sound. These agencies know how to push money to their target beneficiaries. The RBI would do well to push more money through these windows.
Raising the Ways and Means Advance limit for states is a welcome move. An even more welcome move would be for the RBI to directly subscribe to bonds issued by state governments. Yes, this does mean printing money, but it would keep state government borrowing costs low and give the states the spending power they need to provide relief to people in desperate need of it and to spend on healthcare and other urgent priorities even as their revenues tank and the flow of funds from the Centre shrivels up.
In fact, the RBI must pick up fresh bonds issued by the Centre as well, to keep interest rates low even as the government expands the fiscal deficit to give the economy the boost it badly needs.
The regulatory easing relates to easier asset classification, extension of the time period between a loan default and putting in place a resolution plan without having to make a provisioning of 20% on that loan, reduction in the money a bank has to pre-empt on liquid government bonds to cover its cash outgo, effected by lowering the so-called liquidity coverage ratio, and an additional grace period of one year for the real estate sector to start selling built-up homes. All these are welcome.
The RBI horses around with incentives for banks to buy corporate bonds by offering to not force the banks to mark these bonds to the market, and treat them as being held to maturity. This is a disincentive for active trading. If one bank with a good trading desk makes good profits on corporate bonds, it wants the trading profits recognised, not put into some accounting cubbyhole because the traded bonds were supposed to be held to maturity.
Now that horses are truly obsolete as a mode of transport, the RBI should also stop getting mixed up about metaphors on taking a horse to water. It should directly buy corporate and NBFC bonds and kickstart an active market in bond markets.
Source: indiatimes.com