RBI may cut OMOs to prod banks to lower rates

The Reserve Bank of India, frustrated that heavy bond buying has failed to prod cash-strapped banks to lower lending rates, is considering cutting back on such open market operations, several officials with direct knowledge of the matter said.

Instead, it would lend to banks through its daily funds window, the officials said.

The RBI is wary that OMOs, where it buys bonds from the secondary market, is only helping banks to earn profits without stepping up lending activity, which would spur an economy growing at its weakest in a decade.

Banks have not fully passed along to borrowers cuts in policy interest rates, citing the high cost of deposits.

The OMOs have been a key driver of bond market yields, with the announcement of such buying usually helping to pull down yields.

"Banks should work towards mobilising more deposits and not just wait for RBI to pump in money," said one senior central bank official with direct knowledge of the matter.

The cash deficit in the banking system has been far above the RBI's stated comfort zone of about Rs 70,000 crore for most of the last year as a deficit-strapped government slowed spending and as depositors, worried about inflation, withdrew money from banks to invest in gold and other assets.

While banks have called for more OMOs and a reduction in the cash reserve ratio, which is the share of deposits lenders must keep with the RBI, to enable them to lower lending rates, many in the RBI say banks should be doing more.

"Banks have to work harder towards raising deposits ... they should sell their excess G-sec holdings, liquidate them and lend," said another central bank official.

The RBI injected Rs 1.55 lakh crore into the banking system through OMOs in the fiscal year that ended in March but has slowed its purchases since then, holding just two OMOs in three months despite a cash deficit that is nearly twice its target level.

The liquidity deficit has stayed within the RBI's comfort level in only four of the 17 months since the central bank started easing monetary policy, first by lowering the CRR and then cutting interest rates.

Since April 2012, the RBI has cut its policy repo rate by a total of 125 basis points to 7.25 per cent. It has cut the CRR by 200 basis points to 4.00 per cent since January 2012, its lowest in over three decades.

However, most banks have cut base lending rates by only up to 50 basis points.

A third central bank official said that using the daily liquidity adjustment facility (LAF) to meet the cash needs of banks achieves the same purpose as OMOs without incentivising banks to invest in government bonds as opposed to lending.

"LAF is like permanent money because banks can continuously roll it over on a daily basis and it also leads to reserve money growth," the official said.

None of the officials can be identified because they are not allowed to speak to the press.

Already, the central bank has been infusing nearly Rs 1 lakh crore a day on average since April, indicating the extent of banks' cash needs.

With government bond yields subdued, inter-bank call money rates stable and no distress signs among banks, the RBI is not in a hurry to conduct frequent OMOs.

"There is an internal debate on whether to actively conduct OMOs or not as easing interest rates and also easing through quantity, that is liquidity, could be inflationary," the third official said.

Copyright: Thomson Reuters 2013