Banks Look To RBI As Elevated Overnight Funding Rates Raise Liquidity Issues

Indian banks have asked the Reserve Bank of India to help ease funding costs in the overnight market as rates have stayed persistently higher than the repo rate, according to a private and a public sector banker who spoke with BQ Prime on the condition of anonymity.

Overnight funding markets are used by banks to meet their liquidity needs, and an uptick in prices therein is indicative of tightness in system-wide liquidity conditions. While a few large banks are holding surplus liquidity with the central bank, others have become reliant on the overnight market to meet funding needs, the public sector banker mentioned above told BQ Prime.

The weighted average call rate—the rate at which very short-term funds are borrowed and lent in the money market—has risen from 6.4% as of April 6 to 6.76% on May 16. The rise has come against the backdrop of the Monetary Policy Committee keeping rates unchanged in its last policy meeting on April 6.

Even though the central bank pulled the brakes on tightening monetary conditions further in April, the interbank market has raised the cost of short-term funds for banks either way.

The private banker quoted above said that they have asked the RBI to intervene, smooth the liquidity conditions, and ensure that overnight rates do not go materially above the repo rate. The current situation is not untenable but is becoming uncomfortable, this person said.

While banks were expecting the RBI to intervene and cool rates, the central bank's absence came as a bit of a surprise, the public sector banker told BQ Prime. The central bank typically conducts variable-rate repo or reverse repo auctions to fine-tune the liquidity conditions in the banking system.

The central bank not intervening in the overnight market could also signal that it is waiting for cues from the Federal Reserve regarding its balance sheet reduction and monetary policy trajectory, Ajay Manglunia, managing director and head at JM Financial Ltd., told BQ Prime.

By letting overnight rates stay meaningfully above the repo rate, the RBI can also "tighten by stealth", without raising the policy rates explicitly, Manglunia said.

While the weighted average overnight rate has stayed above the repo rate for over a month, it has also moved above the marginal standing facility rate since May 8. The marginal standing facility is a window for banks to borrow from the Reserve Bank of India, and it currently stands at 6.75%.

The MSF is not a popular instrument among public banks, and banks don't typically use it publicly, the public sector banker quoted above said. Even if the MSF offers a rate 2 or 3 basis points below the overnight market, banks prefer not to opt for it, this person said.

On May 16, the weighted average call rate stood at 6.76%, with the weighted average money market repo rate and tri-party repo rates at 6.80% and 6.72%, respectively.