Banks have come under fire from the Reserve Bank of India (RBI) for lending funds borrowed under the liquidity adjustment facility (LAF) in the overnight money market. The central bank has asked the banks not to engage in such a practice, as the purpose of LAF funds is to meet the reserve requirement only.

At least twice last week, RBI officials communicated to banks’ top managements about their discomfort about lending liquidity adjustment facility funds to overnight money market. “Liquidity deficit, which had shot up last week had made the regulator start enquiring about the reason. When they came to know that banks were taking arbitrage opportunity by on-lending the borrowed funds in the call money market, they reminded us that LAF funds should be used for lending purposes,” said a top executive of a public sector bank.

Last week, call rates went past 7 per cent on most days, while the repo rate — the rate at which banks borrow funds from RBI — was 6.5 per cent till the first liquidity adjustment facility of Thursday. On Thursday, RBI raised the reverse repo and the repo rate by 25 basis points each to 5.75 per cent and 6.75 per cent.

According to banking industry officials, some of the foreign banks and small private sector banks were not having excess government paper to pledge funds from liquidity adjustment facility; so they were heavily dependent on the overnight market. Banks, which had excess government bonds, that was above the regulatory requirement of 24 per cent, seized the opportunity for making 50-75 bps margin in the call money market.

“RBI was unable to accept the fact as to why the liquidity deficit should be so high when the government had started spending, despite advance tax outflows,” said another executive from a government-owned bank.

During the November-January period when liquidity shortage was acute, banks were borrowing around Rs 1 lakh crore from RBI on a daily basis. However, from February the quantum of deficit came down to the central bank’s comfort level, which was +/- 1 per cent of banks’ net demand and time liabilities, or Rs 50,000 crore. The deficit, since, has come down because the government has stared spending which was reflected in the fact that government balances with RBI fell from a high of Rs 1 lakh crore in the middle of December to Rs 100 crore in the beginning of March — the minimum level that the government should keep with RBI.

Bankers also said the strain in liquidity in the last week was moreover due to corporate advance tax outflow which was estimated in the region of Rs 50,000 crore.

Source: Business Standard