The new facility will allow the managers of the countrys financial system to deploy the exchequers occasional surpluses from, say, a bountiful advance tax collection or a windfall like the telecom spectrum revenue, for the benefit of the banking system. It will also allow the government to earn some extra returns on its idle cash, while the RBI will be able to even out liquidity variations.
The new mechanism will work as follows: The RBI invites bids from banks willing to borrow at a cut-off price for the excess cash with the exchequer. The RBI auctions cash to banks at the highest bid. As the RBI is aware of the spending plans of the government, it can plan auctions keeping these in mind.
Currently, the RBI uses its liquidity adjustment facility both for short-term lending to and borrowing from commercial banks at a fixed price. The new facility will add another tool of liquidity management to the central banks arsenal.
At times, there is a lumpy liquidity extraction from the system. This happens at times of advance tax collections, in an event of a disinvestment, etc, said Saugata Bhattacharya, senior vice-president, business & economic research, Axis Bank. The government cannot spend this money quickly, so it is parked with the RBI.
Since this is a pool of potential liquidity, auctioning these surpluses is one way of potentially pricing the liquidity, Bhattacharya said.
These will be useful in the event of a liquidity deficit, when banks borrow from RBI's reverse repo window to meet their daily cash needs. Banks borrowed over Rs 1.5 lakh crore every day a couple of months back, before RBI's two-step reduction in the cash reserve ratio. Borrowings from the reverse repo window have become negligible since.
A senior official said the RBI and the finance ministry were working on the contours of the mechanism under which auctions would be conducted at the discretion of the RBI. In recent months, banks have been facing a liquidity crunch, partly due to the slow growth in deposits as investors pursued alternatives like gold.
The central bank can call bids from banks and offer the cash either through uniform price or ascending price based auction. There are other techniques available as well. It will ultimately be a matter of cost. Such auctions will provide RBI with another tool for managing liquidity, but the central bank will use an option which is most cost-effective for the system, a banker said, asking not to be named.
A potential hurdle could be a possible government motivation to hoard cash. It could be useful tool at times when growth in money supply is high, the banker said.
Kotak Mahindra Bank chief economist Indranil Pan said determining the auction price could be difficult since the government's cash balance is mostly in deficit. It would be if the government has a perpetual surplus cash balance with the RBI.
A Reserve Bank working group headed by executive director Deepak Mohanty, had argued in a report in March 2011 for the need to auction surplus cash balances of the government with the central bank.