MUMBAI: Overnight call rate, the rate at which banks lend funds to each other to tide over temporary liquidity mismatches, dropped to 4% on Monday, the lowest since September 2005 as banks rushed to park funds in this market.
The rate, however, recovered during intra-day trades and closed at 5-5.25%, still lower than its previous close of 6.05-6.15%.
The yield on the benchmark 10-year government bond rose to 8.02% before it closed at 7.95%, the level at which it traded last week.
The reason behind the sharp fall in the call rate was the Reserve Bank of India’s (RBI) decision, on Friday, to limit banks’ exposure at its reverse repo window at Rs3,000 crore. RBI sucks out excess liquidity daily from the banking system through this window at 6%.
Over the last few days, banks were parking over Rs20,000 crore at this window. By capping the exposure, RBI has forced the banks either to park their excess liquidity in long-term government bonds or in the overnight market.
“Since banks are not willing to lock for long by buying government bonds, they are making losses by deploying excess money in the overnight market,” says a bond dealer with a public sector bank. This comes from the idea that a bank would rather take on short-term losses, than invest in government bonds, where their money would be locked for a long period of time, such as five to seven years.
Traders say by adjusting the liquidity adjustment facility that is provided to the banks, the central bank is signalling that banks must manage surplus cash on their own instead of mechanically using the reverse repo window to park short-term funds.
Last Friday, RBI had also announced bond auction under the market stabilization scheme (MSS). So far, it has been auctioning short-term treasury bills under this scheme to absorb excess liquidity.
“The MSS will now use a mix of treasury bills and dated securities in a more flexible manner keeping in view the capital flows in the recent period, the assessment of volatility and durability of capital flows, and the paramount importance attached to liquidity management in containing inflation,” RBI had said.
“The MSS is the central bank’s reconfirmation of its hawkish stance. With two cash reserve ratio hikes in quick succession, this is just another tool to suck out liquidity from the banking system,” says another bond dealer.