India’s banking system liquidity has fallen into deficit for the first time in nearly 40 months. In response to the development, the Reserve Bank of India (RBI) recently made the largest financial infusion into the banking system.
What is ‘Banking System Liquidity’?
- In the banking system, liquidity refers to readily available cash that banks require to meet short-term business and financial needs.
- On any given day, the banking system’s liquidity is said to be in deficit if it is a net borrower from the RBI under the Liquidity Adjustment Facility (LAF), and it is said to be in surplus if it is a net lender to the RBI.
- The LAF refers to the operations of the RBI that inject or absorb liquidity into or out of the banking system.
Current deficit in the liquidity of India’s banking system –
- On September 20, 2022, the banking system’s liquidity situation entered a deficit mode for the first time since May 2019.
- In comparison, the liquidity surplus in November 2021 was Rs 8 lakh crore as the RBI provided liquidity support to the economy dealing with the after effects of the Covid pandemic.
What has triggered this deficit?
- Multiple factors are at work here, including an increase in bank credit, advance tax payments by corporations and incremental deposit growth that is not keeping pace with credit demand. In addition, the RBI is constantly intervening to keep the rupee from falling against the US dollar.
- According to the recent RBI data, outstanding bank credit was Rs 124.58 lakh crore on August 26, 2022, up 4.77% (Rs 5.7 lakh crore) from Rs 118.9 lakh crore on March 25, 2022.
- However, deposit growth was only 3.21% (Rs 5.3 lakh crore) from Rs 164.65 lakh crore on March 25, 2022 to Rs 169.94 lakh crore on August 26, 2022.
Impact on consumers –
- Banking system liquidity being in deficit means, banks don’t have sufficient funds for the credit demands coming in from the customers.
- A tight liquidity condition could cause a rise in the yields on government securities, which would then lead to an increase in interest rates for consumers. For example, on September 21, 2022, the 10-year government bond yield increased to 7.23% from 7.18% on August 20, 2022.
- Because the RBI is expected to raise interest rates by another 50 basis points (bps) this cycle, a rise in the repo rate will result in a higher cost of funds.
- Banks will raise their repo-linked lending rates as well as the marginal cost of funds-based lending rate (MCLR), which is linked to all loans.
- Consumers will face higher interest rates as a result of this increase.
Way ahead for RBI –
- Experts believe that the RBI’s actions will be determined by the nature of the liquidity situation.
- If the current liquidity deficit is temporary and primarily due to advance tax flow, the RBI may not need to intervene because the funds will eventually return to the system.
- However, if it is of a long-term nature, the RBI may be forced to take measures to improve the system’s liquidity situation. For example, the central bank has made an infusion of Rs 21,800 crore into the Indian banking system to make it able to continue serving the credit demands of the customers.
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