The Reserve Bank of India on Thursday said it will set up an internal working group to review the current liquidity management framework and suggest measures to simplify it.
“While on the whole, the current liquidity management framework has worked well, it has also become somewhat complex. An assessment of liquidity position by different market participants has varied markedly and is not always in sync with the actual systemic liquidity position in the economy," RBI said.
Central banks operate a liquidity management framework as an integral part of monetary policy implementation; this is achieved by ensuring that the inter-bank call money rate is closer to the benchmark repo rate. Inter-bank call money is where banks lend to each other.
According to an article in the February edition of the RBI bulletin, “The framework comprises forward-looking assessment of liquidity conditions, effective communication with markets, appropriate choice of instrument/s and conduct of liquidity operations consistent with the stance of monetary policy. Even though liquidity management has short-term effects in financial markets, its implications are enduring in terms of its impact on consumption, investment and capital formation in the economy."
The liquidity management framework was last reviewed in 2014. Experts said they expect the RBI to review this framework which ties weighted average overnight call money rate to repo rate.
“I expect RBI to look at the flexibility of linking weighted average call rate to repo or reverse repo. The other suggestion would be to tie liquidity stance with monetary policy stance as liquidity stance can be in surplus, neutral or deficit mode," said Ananth Narayan, professor, S.P. Jain Institute of Management and Research.
The RBI should review the restrictions on borrowing under repo rate, according to Ashutosh Khajuria, chief financial officer at Federal Bank. “Before 2013, there were no restrictions on banks to borrow under repo rate. However, after 2013, RBI capped the borrowing under repo at 0.25% of net demand and time liabilities (NDTL). It is time that RBI removes this restriction," he said.
The RBI last revised the liquidity management framework in 2014 as a way to check volatility in inter-bank call money market, and also allow the lenders to manage their liquidity needs better. Under this revised framework, the RBI said it will ensure frequent term repo auctions to make borrowing more flexible to meet the liquidity needs. The central bank also said it would conduct a 14-day term repurchase auctions up to an aggregate amount equal to 0.75% of the system’s deposit base or NDTL.
Until the revised framework was put in place, the RBI was conducting overnight repo auctions daily, and 7/14 day term repo auctions on an ad hoc basis to smoothen the volatility. But when call rates began to swing in excess of 1% of the repo/reverse repo rates, the RBI decided to conduct 7/14 day term repo auctions on fixed days or according to a pre-determined schedule.
The Urjit Patel committee report on revising and strengthening the monetary policy framework had said that, “to improve transmission of policy rate changes into the spectrum of interest rates in the economy, the excessive focus on the overnight segment of the money market in the existing framework has to be avoided, which will be possible only if the RBI de-emphasises overnight repos for liquidity management and progressively conducts its liquidity management primarily through term repos of different tenors. Development of a term money market through a term-repo driven liquidity management framework could help in establishing market-based benchmarks, which in turn would help improve transmission, if various financial instruments and, in particular, bank deposits and loans are priced off these benchmarks."
Separately, the RBI also said that it is looking to review money market directions to ensure improved monetary policy transmission. Different money market instruments— call money, repo, commercial paper, certificates of deposit and other debt instruments with original maturity less than a year—are governed by different regulatory frameworks.
“With the objective of bringing consistency across products in terms of issuers, investors and other participants, it is proposed to rationalize existing regulations covering different money market products. These directions would improve transparency and safety of money markets," it said.