The Reserve Bank of India (RBI) in a surprise move on Saturday ordered banks to deposit their extra cash with it, in a bid to absorb excess liquidity generated by the ban on 500 and 1,000 rupee notes. According to the RBI’s directive, banks would need to transfer 100 per cent of their cash under the RBI’s cash reserve ratio or CRR from deposits generated between September 16 and November 11. Banking shares tumbled today with the country’s largest lender, State Bank of India (SBI) falling nearly 3 per cent. Here is how the RBI move could impact banks as well as depositors/borrowers:
CRR is a percentage of total deposits of customers which banks have to hold as reserves either in cash or as deposits with the RBI. Banks don’t earn any interest on CRR deposits. The move is likely to drain over Rs 3.24 lakh crore from the banks, according to estimates. “The step had become necessary in context of excessive liquidity in the system to soften the declining bond yields. It was also due to unusual outflow of hard currency from India,” said Economic Affairs Secretary Shaktikanta Das today.
The immediate impact will be lower profitability for banks as they have to pay depositors interest on savings accounts as well as fixed deposits. If the RBI measure is extended till the end of this quarter, there will be a negative impact of 5 basis points on the full-year net interest margin for the banking sector, said domestic brokerage Nirmal Bang.
The RBI’s move will put further downward pressure on bank’s fixed deposit rates, says global financial services major Deutsche Bank. But it does not see a sharp cut in banks’ lending rates as the RBI’s measure will squeeze their margins.
A rally in the debt market could also get derailed, say analysts. Banks had put some of the cash they got from deposits in government bonds, sparking a rally that saw the benchmark 10-year bond yield fall more than 50 basis points to its lowest in more than seven years. Bond prices also fell today, following the RBI move.
The RBI’s action has also tempered market expectations that the central bank will cut interest rates by 25 to 50 basis points at its next policy review scheduled for December 7, say experts. The rally in bond markets had increased hopes that the RBI would lower borrowing costs in the economy and allow banks to reduce some of their lending rates.
Non-banking financial companies or NBFCs will not see benefits of lower funding costs, says global brokerage Morgan Stanley. Banks account for a significant part of the funding requirement for NBFCs.
Emerging market assets, including currencies and stock markets, have tumbled since Donald Trump’s election as US president on expectations he will pursue an expansionary fiscal policy that will drive inflation higher and lead to higher US interest rates. “The strong action could also be aimed at signalling RBI’s reluctance on market interest rates falling too sharply, too soon in the present global context,” Citigroup said.
A sharp fall in the interest rate in the financial system could hurt the rupee which has already hit record lows this month. The higher interest rate in India helps attract foreign investors to Indian debt markets. The rupee today settled at an all-time closing low of 68.76 against dollar as compared to Friday’s close of 68.46.
The government is considering increasing the amount of bonds issued under the so-called market stabilisation scheme to drain out excess cash from the banking system, Mr Das said. The RBI has said the measure to raise CRR is temporary and will be reviewed once the government issues more market stabilisation scheme bonds. A review is likely on or before December 9.