RAJAN EFFECT. For easier transmission of policy rates

Radhika MerwinBL Research Bureau Updated - January 22, 2018 at 09:42 PM.

Reduction in banks’ SLR requirement, review of small savings interest will help

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Apart from keeping markets happy and slashing its key policy repo rate, the RBI has gone a step further to smoothen the transmission of policy rates. In keeping with the recommendations of the Urjit Patel Committee, the RBI has sought to align interest rates across different segments to market-determined rates. For one, the RBI has decided to bring down the total SLR requirement (statutory liquidity) — government securities held by banks — in a phased manner from next year. It has also made it less viable for banks to stock up excess government securities than mandated, by reducing the limit on such securities, maintained in the held-till-maturity (HTM) category.

Lowering SLR Banks are currently required to hold 21.5 per cent of deposits as Statutory Liquidity Ratio. The RBI has decided to lower this by 0.25 per cent every quarter, starting next year till March 2017. This will free up close to ₹20,000 crore of banks’ funds at every stage.

This is more a gesture towards its long-term policy objective. One, loosening up banks’ kitty, to boost investment . Two, this is expected to facilitate better transmission of policy rates to depositors or lenders. By reducing SLR, the RBI wants to do away with a captive market for government securities. This will make the bond yields reflect actual market demand. In the past, there has been a ready market for bond buy backs by the RBI through open market operations as well as through the SLR mandate. This has kept rates on government borrowing suppressed.

So from a longer term perspective, this will ensure that every segment of yield curve moves to market-determined rates.

But reducing the total SLR requirement for banks, as in the past, alone cannot free up funds. This is because banks on an average invest 3-5 per cent more than the mandated requirement. Banks carry excess investments due to lack of viable lending opportunities and due to the comfort of parking funds in highly safe assets, which can be used as collateral to borrow from the RBI.

But what could force the banks’ hands to some extent, is the reduction in the ceiling of HTM. Banks are allowed to keep a portion of their SLR securities under HTM, which do not have to be adjusted to reflect their market value at the end of every quarter. This lowers the volatility in their treasury income.

Currently banks are allowed to hold more securities in HTM category (22 per cent), than the mandated level of SLR. The RBI will reduce the HTM ceiling by 0.5 per cent in January 2016, to align it with the total SLR requirement.

From the banks’ perspective, this will mean changes in market value for a higher proportion of SLR securities will now have to be accounted for in banks’ income statements.

Small savings scheme To ensure better transmission, the Urjit Patel committee report had also recommended intra-year review of interest rates on small savings scheme, to align them to the benchmark G-Sec yield.

These schemes have a competitive edge over bank deposits. So banks have not been able to cut deposit rates beyond a point to stay competitive with these schemes that offer much better post tax returns.

This year, despite the steep fall in yields of government bonds, the Centre kept rates unchanged on small savings schemes. The five-year NSC carries an interest rate of 8.5 per cent, which for the 10, 20 and 30 per cent tax brackets, works out to post tax return of 10.7, 13.3 and 16.3 per cent, respectively.

A review of rates on small savings will give more headroom for banks to lower deposits rates and hence lending rates.

Published on September 29, 2015 17:07