RBI has announced a new liquidity facility under Long Term Repo Operations (LTRO) to inject liquidity in the banking system. The new policy tool comes in the context of the RBI’s limitations in cutting its policy rate as well as its desire to enhance liquidity of the banking system and promote lending activities of banks.
An interesting feature of the RBI’s new effort is that the central bank will be injecting Rs 1 lakh crore into the banking system through auctions with long term maturity periods (compared to one day repos) of 1 year and 3 year.
Funds through LTRO will be provided at the repo rate. This means that banks can avail one year and three-year loans at the same interest rate of one day repo. Usually, loans with higher maturity period (here like 1 year and 3 year) will have higher interest rate compared to short term (repo) loans.
If the RBI is ready to give one-year and three year loans at the low repo rate, then there will be a clear pressure on banks to reduce thier lending rates. Hence, the most important effect of the LTRO in the system will be a decline in short term lending rates of banks. There are two clear effects of LTROs:
(a) it will enhance liquidity in the banking system by Rs 1 lakh crore
(b) since the interest rate is comparatively low, there will be a downard pressure on short term lending rates.
These two will bring the effect of a slightly easy monetary policy.
According to the RBI, the LTRO scheme will be in addition to the existing LAF and MSF (Marginal Standing Facility) operations. The LAF and MSF are the two sets of liquidity operations by the RBI with the LAF having a number of tools like repo, reverse repo, term repo etc.
Objectives of LTRO
- To assure banks about the availability of durable liquidity at reasonable cost relative to prevailing market conditions.
- Further encourage banks to undertake maturity transformation smoothly and seamlessly so as to augment credit flows to productive sectors.
While announcing the LTRO, the RBI also hinted that the current liquidity framework may be revised soon. The current liquidity framework involves LAF family instruments like repo, reverse repo, term repo etc and the Marginal Standing Facility.
RBI announced a timetable for undertaking the LTRO.
Features of Long-Term Repo Operations (LTRO)
Following are the features of the LTRO:
- Maturity period (tenor): One-year and three-year tenors
- Total funds to be injected: Up to Rs 1,00,000 crores
- Interest rate: at the prevailing policy rate (Repo rate).
- Method of fund injection: CBS (E-KUBER) platform. The operations would be conducted at a fixed rate.
- Banks would be required to place their requests for the amount sought under LTRO during the window timing at the prevailing policy repo rate. Bids below or above policy rate will be rejected.
- If there is over-subscription of the notified amount, the allotment will be done on pro-rata basis. RBI will, however, reserve the right to inject marginally higher amount than the notified amount due to rounding effects.
- The minimum bid amount would be Rupees one crore and multiples thereof. There will be no restriction on the maximum amount of bidding by individual bidders.
- The eligible collateral and the applicable haircuts for LTRO will remain the same as applicable for LAF.
- All other terms and conditions as applicable to LAF operations for the LTRO.
Potential effects of the LTRO
Since, under LTRO, funds are provided at low interest rate of the reop rate, the overall short-term interest rate may come under pressure to register a decline. Similarly, the short-term yield also may fall. Altogether, there will be pressure on the banking system to reduce their lending rates.
New Liquidity Framework by the RBI
The Reserve Bank announced a revised liquidity Framework on February 6, 2020. On the previous day, the RBI announced the launch of a new liquidity instrument called Long Term Repo Operations. Following are the components of the liquidity framework announced by the RBI.
|A. Instruments under LAF framework to manage short-term/transient liquidity|
|1.||14-day variable-rate repo/reverse repo auction (Main operation)||Auction amount will be decided by the RBI based on the assessment of liquidity conditions.||On Friday|
|2.||Variable Rate Term Repo/Reverse Repo auction (Tenor: overnight and up to 13 days) (Fine-tuning operations)||The auction amount will be decided by the RBI, based on an assessment of the liquidity conditions.||Discretionary|
|Fixed Rate Repo|
|3.||Fixed Rate Reverse Repo||No restriction on amount||Daily (Including Saturdays, Sundays and holidays) between 5.30 PM and 11.59 PM|
|4.||Marginal Standing Facility (MSF)||Individual banks can draw funds up to Excess SLR + 2 per cent below SLR.|
|5.||FX Swaps||The amount will be decided by the RBI, based on the assessment of the liquidity conditions||Discretionary|
|6.||Standing Deposit Facility (SDF)||Operational details of Standing Deposit Facility (SDF) will be issued separately.|
|B. Instruments to manage durable liquidity|
|Long Term Variable Rate Repo (LTR): beyond 14 days||The auction amount will be decided by the Reserve Bank, based on an assessment of the liquidity conditions.||Discretionary|
|8.||Long Term Variable Rate Reverse Repo (LTRR): beyond 14 days|
|9.||FX Swap Auctions||The auction amount will be decided by the Reserve Bank, based on an assessment of the liquidity conditions.||Discretionary|
How the LTRO is different from the existing term repo?
Already, the RBI is having term repo instrument to inject money into the banking system by providing higher than one day loans. The term structure is higher but less than 14 days. Interest rate will be higher than repo rate. In this context, following is a comparison between the term repo and LTRO.
|Interest rate||Fixed and at repo rate||Variable, depending upon auctions but higher than repo rate.|
|Term structure||1 year or 3 year||1 to 13 days|
|Individual bank’s bid size||No restriction on the maximum amount of bidding by individual bidders.||0.75% of the banks’ NDTL.|
|Disbursal||Auction (e-Kuber)||Auction (e-Kuber)|
|Applicants||Scheduled commercial banks||Scheduled commercial banks|
|Collateral||Same as under LAF||Same as under LAF|
|Total fund injections||Limit to be determined by the RBI||Limit to be determined by the RBI|