The central bank has a range of policy options that would prevent banks from sitting idle on their cash. It can cap how much money banks can keep in the reverse repo window. A standing deposit facility (SDF) will allow the RBI to accept as many surplus funds banks have to offer, but at a rate lower than the reverse
(which is currently at 3.75 per cent). The central bank can use both the reverse repo cap and also the SDF. As an extreme measure, the RBI can simply charge banks for keeping money with it, say economists.
Banks would lend if they reckoned they could be penalised for excess liquidity, helping to restart the economy. In the absence of a government stimulus, banks are sitting tight.
“A negative interest rate also cannot force the banks to lend when the government is not willing to take the bet with a stimulus package,” said a senior economist requesting anonymity.
Banks are using the excess liquidity to invest in state bonds-- state development loans (SDL) --as near risk-free assets. SDL seem to be back in favour with bond investors and banks. Spreads between the SDL yields and those of the central government bonds have come down to almost normal levels as a result.
The Reserve Bank of India
(RBI) on Tuesday auctioned bonds of nine state governments and the union territories of Jammu and Kashmir. Madhya Pradesh’s 10-year bond cut-off was at 6.69 per cent. Jammu and Kashmir’s 10-year bond cut-off was at 6.79 per cent. In constrast, the 10-year government securities yields closed at 6.07 per cent. This indicated that the spreads have contracted to 60-70 basis points. This is just about the spread seen during normal times.
However, in the first auction of the financial year, the state governments paid 140 to 200 basis points above the equivalent maturity Gsecs, as markets feared a deluge of supply.
Since then, the government has addressed supply concerns. Earlier, the expectation was that states will crowd in to borrow 50 per cent of their requirement in the first quarter itself, but the government said they can do so by December. Then the Reserve Bank of India
(RBI) also increased states’ ways and means advances (WMA) by 60 per cent.
The cut-off on SDLs are soft because of lower supply than expected due to increase in WMA limit for states, according to Devendra Dash, head of asset-liability management at AU SFB.
“The supply concerns addressed, markets have no reason to ask high yields from states. Besides, banks have excess liquidity and no credit off-take. The money is best utilised in whatever good quality paper is available,” said a bank treasurer who did not want to be quoted.
On Tuesday’s auction, Gujarat choose not to accept any amount, but other states raised the full amount they had planned.