Column : RBIs sixth sense on stability

Written by Saugata Bhattacharya | Updated: Oct 30 2009, 03:44am hrs
Reading RBIs 2009-10 mid-term policy review is a bit like watching the film The Sixth Sense; every re-visit reveals a new dimension. The purpose of this column is to attempt at motivating the choice of the measures as well as a look at the implications. This is not, unfortunately, a blinding revelation; much is already in the policy statement itself, which is one of the best written and cogently argued documents from an official agency. The RBI, besides signalling a change from its erstwhile expansionary stance, has also sought to balance concerns on inflation and growth, support the central and state governments massive borrowing programme, even while seeking a revival in credit offtake from banks and de-risk the banking sector (and financial intermediation in general).

First, this was more a credit policy, a banking policy, than a monetary policy, per se. It has also sought to increase the role of the banking sector as the main transmission channel for monetary policy. As our readers will now be aware, RBI chose to maintain most of the key signalling policy rates (the repo and reverse repo, and the bank rate). Note that I have not included the CRR, since although the system CRR was held, an incremental charge was added by bringing in funds borrowed by banks from the Collateralised Borrowing and Lending Obligation (CBLO) repo facility. However, this is likely to be a transient charge as gradually tightening liquidity will reduce the quantum of borrowings. Even otherwise, the incremental CRR at current borrowing levels is likely to be small.

It also chose to increase the SLR from the current 24% of bank funds to 25%, in a move many seem to consider surprising. Maybe the element of surprise should have been lower. Remember HTM The clamour for increasing the ratio of government securities held by banks in their held-to-maturity portfolios had been increasing and stock markets had apparently actually begun to believe this to be a fait accompli. This was sought to provide comfort to bond traders in managing their accounting losses (how will be the subject of a separate column) with the objective of facilitating the absorption of future market issues by the government. This step, however, would have been quite deleterious to the process of subjecting intermediaries to market discipline, of which accounting is a key pillar. The SLR increase was an alternative comfort, much less problematic. The impact will be small, largely applicable to a narrow set of banks; a large part of the system already has SLR holdings well over 27%.

A big deal is being made out of RBIs quenching the multiple liquidity and refinancing facilities opened during the early days of the financial crisis. Although a statement of intent on the exercise of an exit option, these would be largely non-operative; most of the measures were not being used at all; some had not been used even during the peak of the liquidity shortage. Of the measures withdrawn, the facility of export credit refinancing might become a problem later on, though. The interest rate on the refinancing facility was the repo rate (4.75%) and banks can now access funds at much cheaper rates. If there were, however, to arise a liquidity shortage in the future, this facility might need to be accessed, if cheap export credit needs to be maintained. But this is a minor quibble; a refinance facility can then be reinstated.

The set of measures related to banks provisioning of NPAs and standard assets is clearly the outcome of a regulator worried about potential increase in bad loans, particularly given the significant build-up of restructured assets. An emphasis on financial stability is never far from a regulators mind these days, after the harrowing experience of the last couple of years. Non-residential real estate lending has also remained a sensitive area, and the run-up in equity markets is clearly seen as a precursor to increase in real estate prices. Commercial real estate is seen as particularly vulnerable.

A very significant action, related to the above measures, which seems to have escaped general notice, was the imposition of a years lock-in on loans, before which they cannot be securitised. This will have an adverse impact on banks business, but RBIs motivation is apparent. Mutual funds have been major buyers of these securitised loans. Based on their learnings of the global financial crisis, RBI will have perceived the gradual emergence of a shadow banking system, just as the SIVs and hedge funds were in developed markets. This move also needs to be seen in conjunction with the cap on sub-base rate loans that has been proposed in the earlier draft report of the Working Group. That had raised the worry of diversion of significant business away from banks towards other entities, particularly mutual funds.

As we had noted earlier, this was a complex exercise in balancing various objectives in a very uncertain environment, where a small mis-step can have a potentially magnified systemic impact. The review carried this off with lan.

The author is vice-president, business & economic research, Axis Bank. Views are personal