By T. Bijoy Idicheriah, Cogencis
In a simple move today, Reserve Bank of India Governor Raghuram Rajan gave banks the flexibility to tap their Statutory Liquidity Ratio holdings for liquidity to meet their Liquidity Coverage Ratio. By ensuring that such flexibility does not impact government borrowing plans, even when it helps banks migrate to LCR and also adhere to Basel III requirements, Rajan has hit many birds with one stone. From a liquidity standpoint, he has, in effect, cut SLR without really cutting it.
The RBI today said it would allow banks to include government securities up to another 5% of their Net Demand and Time Liabilities held under SLR to be counted as level 1 high-quality liquid assets in the proposed LCR. So far, banks were only allowed to dip into their mandated SLR up to 2% of NDTL to borrow under the RBI’s Marginal Standing Facility.
The additional 5% liquidity will be available through a special facility, at a rate higher than the current MSF level of 9%. It is important to note that the RBI has always been keen to bring down SLR levels, but has been constrained by the fact that SLR is directly linked to the government’s ability to achieve fiscal consolidation.
Banks have been compelled to buy government bonds to meet their SLR requirements as mandated by the RBI — which effectively helps the government meet its borrowing requirements cost effectively.
However, the introduction of the Basel III framework and the insistence of the Basel committee that India’s SLR does not meet its requirements under LCR, have provided the RBI the opportunity needed to start bringing down SLR levels.
The Basel committee thinks that SLR holdings are a regulatory requirement, and hence are not unencumbered high-quality liquid assets that a bank can sell if it is in a stress scenario. For, SLR is encumbered by RBI regulations and so does not fit Basel’s view of LCR.
The key difference between SLR and LCR is not just that SLR is encumbered but that LCR is managed by banks and has a broader pool of eligible securities, including banks’ deposits and other high-quality assets.
Banks have to achieve 60% of LCR as on Jan 1, which will progressively rise to 100% by January 2019.
RBI Governor Raghuram Rajan had already indicated that he would provide banks further room to meet their global liquidity requirement under Basel III by providing space under the existing SLR.
At the Aug 5 post-policy interaction, Rajan had said that the RBI was keen to “give banks more flexibility in meeting the liquidity coverage ratio, and first as we bring down SLR over time they will be able to make an independent decision on what they hold to meet the liquidity coverage ratio”.
As per the original LCR norms, banks had the leeway to borrow against up to 2% of their SLR holdings under MSF. This freed up 2% holding out of the existing 22% SLR requirement, and made it possible for banks to borrow against them. It effectively also meant that only 20% out of the 22% held under SLR met the original definition of SLR, which was that it was encumbered and not a liquid asset for banks.
However, with today’s move of allowing further leeway of 5% under SLR to meet LCR norms, Rajan has paved the way for freeing up to 7% of current SLR holdings and effectively making them unencumbered, in line with LCR requirements as stated by Basel.
Speaking to the media today, Rajan said that historically SLR had two functions – liquidity and providing a boost to government borrowing. “Right now, we want to deal with the problem of LCR, which is kicking in earlier than the evolution of SLR. So given that, then the special facility we will open, there will be some conditions on where we will open, we will have to make sure that’s consistent with Basel requirements. So that will give the banks flexibility to bounce off those existing SLR holdings as part of their liquidity coverage so they don’t have to maintain additional liquidity, that’s all.”
While it is true that banks have been under pressure to meet LCR requirements, in addition to holding SLR assets at 22% of NDTL, the RBI has been able to leverage this opportunity to bring down SLR, without hurting the government borrowing.
By parking his gun on Basel’s shoulders, Rajan may have just managed to pull off a move on SLR that his predecessors spoke about but were unable to push through.
Edited by Siva Sankar
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