Liquidity coverage: Don’t add to the regulatory burden on banks

RBI is proactively looking to ensure there is no liquidity crisis even during periods of acute stress.
RBI is proactively looking to ensure there is no liquidity crisis even during periods of acute stress.

Summary

  • RBI’s review of the liquidity coverage ratio of banks should look for better options to reduce the risk of a cash crisis. Digital transfers are soaring. Limiting some online transactions to business hours might work.

While presenting the first monetary policy statement for fiscal 2024-25 in April, Reserve Bank of India Governor Shaktikanta Das had announced that RBI would review its liquidity coverage ratio (LCR) framework to ensure smooth functioning of the system even in the event of acute stress. His concern, he said, was driven by “recent events in other countries [that] have shown that digital channels have been used by customers to quickly withdraw or transfer funds from banks." 

Today, technology has enabled instantaneous transfers, with the result that banks are faced with a stiff challenge in managing their liquidity position to make sure they have sufficient cash at all times. Under the Banking Regulation Act of 1949, banking is the business of taking deposits “repayable on demand." Hence, banks must always be able to honour any and all demands from customers for repayment.

The governor stressed that it is during “acute stress" that a framework like LCR—a prudential tool to check a bank’s ability to meet cash outflows in the near future—is most needed. While this is clearly true, a better option is to fool-proof the system in a way that minimizes the scope for such events, rather than wait for an implosion and then scramble to pick up the pieces. 

Presumably, RBI does not want to be caught napping, like some of its Western counterparts, and hence is proactively looking to ensure there is no liquidity crisis even during periods of acute stress. This is welcome. After all, there is always space to fine-tune prudential regulations and get them up to speed. 

Also read: Banking system liquidity deficit down to 1.40 ­lakh crore: Report

But in a scenario where the compliance burden on banks has grown almost exponentially, can we instead devise an alternate mechanism for banks to manage their liquidity (withdrawals on a day-to-day basis) more efficiently? This task has become much more complicated as online transfers soar across the country, letting virtually all bank customers withdraw funds 24/7 at the swipe of a thumb. 

Today, one of the main causes of cash-flow uncertainty that banks face is on account of real-time fund transfers; any unexpected large outflow can potentially result in a liquidity crisis. It is true that the ‘traditional banking model’ of commercial banks in India, by which they raise funds chiefly through current and savings accounts and depend less on bulk deposits, is a cause for comfort. After all, it is highly unlikely that a majority of depositors will pull out their deposits at the same time—a dangerous event called a bank run.

Nonetheless, could we reduce the admittedly low probability of an acute-stress event by the simple expedient of tweaking the existing rules that govern online transfers? Could we allow banks to limit online transfers, particularly real time gross settlement (RTGS) transfers? These tend to be of very high value and are usually business-related transactions, so they could be scheduled from, say, 08:00 to 18:00 hours. 

Such restrictions are not without parallel. Stock market transactions, for instance, have to be done during the stipulated opening and closing hours. Remember, unlike retail payments that tend to be small and are often unplanned, business payments are both large and typically planned in advance. Hence, these could easily be scheduled during work hours without impairing business efficiency, while adding hugely to the comfort of banks on the liquidity front. Apart, of course, from reducing potential risks to the stability of our financial system.

Also read: Banks rush out deposit rate hikes in scramble for cash

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