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Informist, Wednesday, May 21, 2025

 

By Cassandra Carvalho and Vidhushi RajPurohit

 

MUMBAI – Suggestions and speculation on the changes that the Reserve Bank of India will make to its liquidity management framework have gained steam ahead of the central bank's second meeting with bank officials on the subject Wednesday, bond market participants from banks said. Among myriad changes on bankers' minds, the one gaining most currency is that the Liquidity Adjustment Facility corridor be widened on either side of the central bank's repo rate by 25 basis points each.

 

Currently, the width of the corridor is 50 bps with the floor Standing Deposit Facility rate at 5.75% and the ceiling Marginal Standing Facility rate of 6.25%, with the repo rate at the 6.00% mid-point. Should the framework contain such a change, the corridor would stand at 5.50-6.50%. Bank executives could have proposed a revision of corridor to a spread of 50 bps each between the repo rate on Wednesday, treasury officials said. Some banks which had met the RBI on Apr. 3 had also made the suggestion, they said.

 

"Maybe the window between SDF and MSF might be extended by 25 basis points on either side of the repo," a dealer at a private sector bank said. "People want this to happen because then our operating rate is half a percent point lower than repo rate. It is de facto another cut and (will) ease the liquidity shackle."

 

Some dealers were of the view that extending the Liquidity Adjustment Facility corridor is necessary given the downward policy rate trajectory. Policy transmission would be smoother if money market rates swung well below or above the repo rate, which would then translate to moves in interest rates throughout the banking system and economy that would better align with the direction of monetary policy, they said. The RBI's Monetary Policy Committee has cut the policy repo rate by 50 bps since February, and softened its stance to "accommodative" in April. However, other traders said this would dilute the signalling power of the policy repo rate decided on by the MPC and untether money market rates from the repo rate. 

 

Informist had reported on Thursday that the RBI had called some banks for a meeting on Wednesday to discuss changes to the central bank's liquidity management framework. The current framework dates back to February 2020, with 14-day variable rate repo and reverse repo operations acting as the main instruments to manage temporary liquidity mismatches.

 

Traders also expect the talks between RBI and banks to include a shift in the operating target of the monetary policy from the weighted average call rate to a new benchmark rate called the Secured Overnight Rupee Rate, or SORR, which the central bank proposed to introduce in December. The central bank has been trying to revive the call money market since last year and it has nudged banks on several occasions to be more active in lending their surplus funds in the market instead of passively parking it with the RBI at the Standing Deposit Facility. However, traders expect the central bank to shift the benchmark rate for a more accurate representation of the monetary policy actions.

 

With the new liquidity framework in consultation externally since April, traders said an internal review within the central bank had likely begun in January or February. As such, most traders said they expect changes to be announced along with the next monetary policy review outcome on Jun. 6. However, since the 'SORR' has only been conceptualised and not yet set up or traded, the implementation of it as the benchmark in the new liquidity framework may either delay the rollout or lead to a phased change in the operating target. In any case, market participants said some changes away from the current framework have already taken effect de facto.

 

 

The RBI had announced on Jan. 15 that it would hold daily variable rate repo auctions to support banks' requirements for funds, until further notice. Primary dealerships are also allowed to participate in these auctions. However, the average subscription has been a mere INR 57.19 billion at auctions this month, against a notified quantum of INR 250.00 billion at each auction. Calls for an 'on-tap' or fixed rate repo system are also gaining traction, which was part of the RBI's liquidity management before 2020.

 

A return to on-tap operations would also entail a limit that banks could borrow. In the prior liquidity framework from 2014, the overnight fixed rate repos were applicable up to 0.25% of a bank's net demand and time liabilities and supplemented by overnight variable rate repos of RBI-announced quantums as needed. This was a key demand from bankers in the first meeting, and was part of the agenda of the Wednesday meeting as well, they said.

 

Bank officials also wanted a reduction in the cash reserve requirement ratio or more flexibility in the cash maintenance norms. Bankers said that top executives were likely to propose a 'dynamic CRR', wherein the minimum requirement for reserves could change on a daily basis depending on the fluctuating liquidity conditions. The central bank had in December cut the cash reserve ratio by 50 bps to 4.00% of bank's net demand and time liabilities, with some sections of the market calling for further CRR cuts. This buffer to tide over times of crisis and large withdrawals is fulfilled by banks' Liquidity Coverage Ratio, bankers said. 

 

With a wishlist ready and more conjecture about the framework every day, traders are eagerly anticipating the changes and hope that these will lead to further liquidity in the hands of banks, which may be deployed to both credit and fixed-income investments. Bond yields reversed a rise earlier Wednesday on speculation some of these changes were imminent. All eyes are now on the RBI and its communication on how it wants to define the next era of its liquidity management.  End

 

(With inputs from Aaryan Khanna)

 

Edited by Akul Nishant Akhoury

 

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