My views on RBI Governor statement on MPC 10th Augusr2023

RBI Governor Statement on MPC Discussions

1. Is there any invisible stress in the financial sector? Reserve Bank of India (RBI) Governor, normally, comes out with a statement of decisions taken by the Monetary Policy Committee (MPC), after the meeting of MPC is over, reviewing the repo rate in the light of prevailing inflation rate, international and domestic developments that might influence inflation positively or negatively. On 10^th August 2023, he announced that the repo rate  is unchanged and that the monetary policy stance continues to be "remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth". He mentioned “During tranquil and good times that vulnerabilities may creep in. Hence, buffers are best built up during these periods. A stable financial system is a prerequisite for price stability and sustained growth. This is a shared responsibility in which regulated entities like banks, NBFCs and others are important stakeholders". This is not the first time that the RBI Governor is stressing that buffers needs to be built up adequately in the financial system. In fact, in all the meetings and conferences he attended, whether it pertains to addressing a particular set of audience like independent directors or otherwise, he does caution the weakness that might come in the financial system. I remember him, while addressing the independent directors of banks, pointing out that RBI, during the course of inspections/ supervisory process of commercial banks, did come across gaps in governance of certain banks, with the potential to cause some degree of volatility in the banking sector. By citing a few examples, he also mentioned that in a few banks, where one method of evergreening, after being pointed out by the regulator, was replaced by another method. In the light of the repeated observations on the need to build up buffers from RBI Governor himself, when the banking system is reporting the highest CAR much above the regulatory prescription of 11.5%, I wonder whether there is any invisible stress in the financial sector. Or, is it that RBI apprehends that the stress should not happen, as in the past, when accelerated continued credit growth  was followed by an increase in the level of NPAs, added provisions and erosion in net profit/net worth.

2. Understanding Incremental Cash Reserve Ratio (I-CRR): RBI said that a little over Rs. One lac crore might be impounded by its decision to introduce I-CRR at 10% of the increase in DTL (demand and time liabilities) between 19^th May 2023 and 28^th July 2023, which is over and above the normal CRR of 4.5% to be maintained by the scheduled commercial banks. 

I just tried to make a sense of what could have triggered this decision from RBI. The following table is prepared from the weekly extracts published by RBI and the growth levels indicated as on 28.07.23. The table does not include the impact of the merger of a non-bank with a bank from 1st July 2023.

(Rs. In lac cr.)

Description	Growth in FY 23-24 up to 19.05.23	Growth in FY 23-24 up to 28.07.23	Growth between 19.05.23 and 28.07.23
Deposits	3.31	9.73	6.42
Borrowings	0.08	3.39	3.31
Other DTL	0.07	0.30	0.23
Total increase in resources	3.46	13.42	9.96
Bank Credit Growth	2.18	5.11	2.93
Incremental Cash Reserve ratio at 10%	NA	NA	1.00

From the above table, I felt that the nearly 200% increase in the growth of deposits from the growth level as on 19^th May 2023 and the 72% increase in borrowings as on 28^th July 2023 from the levels as on 31.03.2023 could have prompted RBI to bring in a liquidity check in the form of I-CRR.

Implications, in my opinion:

(i) The increase in borrowings (as they may carry higher rates than deposits) of the banks concerned (that contributed to the increase) should be brought down, if the said banks have to avoid the impact of I-CRR in their earnings.

(ii) The pace of credit growth may come down further across the banks, as they will be short of money or may have to liquidate yield linked investments, to continue the growth story in advances.

(iii) Lending rates linked to internal bench marks will go up, as cost of funds will increase. since the amount to be kept with RBI as I-CRR do not earn any interest. (Retail and MSME Loans linked to external bench mark, mostly to repo, have already increased, whenever there was a change in repo). Some banks have already announced their decision to increase MCLR rates.

(iii) There was a newspaper report that top banks vie with each other to garner top rated big corporate advances by offering competitive rates. Funding such advances are normally resorted to by banks by raising CDs/high cost term deposits from corporates, as  bulk money is needed in a short time to finance. This may get corrected now, which in turn might stabilise the bulk deposit/CD rates

(iv) Interest rate on unsecured advances, loans to unrated borrowers, micro finance and credit cards may not see an increase, since they are already at high levels, whether linked with repo rate or not.

(v) Increase in deposit rates/CDs are unlikely since the banks might apprehend of implications, if the I-CRR were to continue.

My Views: I-CRR might be the first tool employed by RBI in implementing its monetary stance that "remain focused on withdrawal of accommodation".  Though the Governor has promised to look into the issue on or before 8th September 2023, so as to enable banks to meet the credit needs of the borrowers during the festival season ahead, CPI inflation at 7.44% in July 2023 will be a major stumble block, unless the inflation numbers for August 2023, corrects itself to below 5% once again.

Increase in repo rate due to increase in CPI inflation, looks unlikely for now, due to two reasons.

(i)           The borrowers are already feeling the heat and

(ii)      The general elections are due in less than a year. 

Hence RBI may continue to focus on 'withdrawal of accommodation". My sense is that RBI may settle down at 5% of incremental CRR over the DTL increase in FY 2022-23. And if the situation does not improve considerably, it may even look at increasing the statutory liquidity ratio (SLR) by 50 basis points, which might compel banks with just adequate SLR, to correct their accelerated credit growth. RBI also may look at some of the risk weights assigned to loan assets, especially the unsecured.

Regards

V.Viswanathan

21st August 2023.

Just a thought: There are some, who advocate that the food index in compiling CPI inflation needs a review as certain food items are seasonal in nature. But is it not a fact that food is an essential part that needs stability, as it affects the 'low income' and lower middle class' people' - normally referred to as the 'common man' - the most.