Here is an attempt to decode it for you. To keep the wheels of the economy turning, the RBI has taken four key steps. One, increase the liquidity in the system Two, make sure the lower policy rate is transmitted. Three, give a three-month window for a payback on all term loans. Four, take steps to reduce volatility and provide stability.
Steps one and two are linked and I will explain them together. He announced a big cut in the repo rate by 75 basis points (100 basis points makes a percent, so three quarters of a percentage point) to 4.4%. Repo rate is the rate at which the banks borrow from the RBI. Banks give ‘eligible securities’ they hold for cash that RBI gives as an overnight loan. Banks pay the repo rate as interest for this borrowing.
When the repo rate is high, banks find it costly to borrow and in turn raise the price of loans to their borrowers. A low repo rate has the overall effect of reducing interest rates for the system. Lower rates makes it easier for entrepreneurs to take loans for working capital and for households for homes, vehicles and so on.
But previous rate cuts have not been ‘transmitted’ by the banks who have not reduced lending rates and have preferred to keep money with the RBI at the ‘reverse repo rate’. This is the rate at which banks lend to the RBI. The RBI has now reduced the reverse repo rate by 90 basis points to 4%, making the cut sharper than the one on the repo rate to encourage banks to borrow from the RBI rather than lend to it.
Banks have preferred to deposit money with the RBI rather than lend it out with an average daily amount of ₹3 trillion being kept with the RBI. A reduction of the reverse repo to 4% makes it unattractive to banks to park it with the RBI and banks will be nudged to lend.
Bank lending provides the needed oxygen to businesses for their working capital and longer-term loans. Read this as a measure to help banks take the decision to lend rather than play it safe by keeping money with the RBI.
If people are in a lock-down, the wheels of the economy begin to grind down and there is a rush to safety for money in the system. Investors begin to redeem their shares, bonds and mutual funds. These redemptions cause a fire sale of assets. Finally, when there are no buyers, markets begin to freeze.
To keep the wheels of the markets well-oiled with cash, the RBI has made ₹3.74 trillion available. This it has done using four weapons. One, it has used targeted long-term repo operations. RBI will lend money to banks (a total of ₹1 trillion) that can be invested in bonds and other forms of lending instruments. The key part in this is that these investments will not be considered under the mark-to-market system but under the held-to-maturity classification. What this means is that the MTM road values the bonds at the price they get in the market today, but when markets are in distress the prices could be wrong or not available.
Under the hold-to-maturity way the portfolio is valued not on the market price but on what the price should be given the rate of interest of the bond, the holding period and the rating of the bond. Basically, it allows trades to happen at a price that is not confused with the current pandemic in the market.
Two, reduced the cash reserve ratio by a full percentage point down to 3% for a year. The CRR is the percentage of demand and time deposits banks have to keep with the RBI. So if you deposit ₹1 lakh, ₹4,000 cannot be used by the bank to lend since it needs to keep this with the RBI as a ‘reserve’.
Remember that there is another 18.25% of deposits that is also not used for lending under the Statutory Liquidity Ratio (SLR), further reducing the money banks have to lend. RBI has reduced the CRR to 3%, freeing up ₹1.37 trillion for banks to lend. CRR has been chosen rather than SLR because this increases ‘primary liquidity’ with the banks a bit better. Not only is there CRR rate down, banks now need to maintain 80% of the limit on a daily basis instead of 90% till June 26, 2020.
Three, ₹1.37 trillion will be made available under the emergency lending window called the marginal standing facility (MSF). Banks will now be able to borrow 3% of their deposits under this window, up from the current 2%. Basically, RBI is willing to lend more than before. How much more? ₹1.37 trillion under this window.
Four, hiked the corridor by 15 basis points. This means that the cost of lending to the RBI has gone down more than the cost of borrowing. Both costs have gone down, but when banks lend to the RBI, they get a lower return than before, in comparison to the rate at which they borrow. In effect, banks are being pushed to lend more.
Third, this what the experts have been talking about the past two weeks – regulatory forbearance. What this means is that as economic activity grinds to a slowdown, people will not be able to pay back the loans they have taken for no fault of theirs. This could be businesses with loans, households with EMIs on home loans and others with what are called ‘term loans’. RBI will allow a moratorium of three months for loan repayment.
This means if you can’t pay, you have a window of three months before the bank, NBFC, housing finance company, micro finance firm can haul you up or spoil your credit report. This is a relief especially for small entrepreneurs who have been forced to shut shop and for employees whose incomes have stopped since their place of work is shut. It is good that the RBI has looked at the retail part of the market along with the corporate sector for once. Working capital loans don’t come under the ‘term loan’ category, and these borrowers can defer paying interest for three months till June 2020. But will have to pay the entire interest at the end of the period. Neither will the assets be classified as NPAs, nor will they see a credit rating downgrade, nor will individual credit scores get hit.
Fourth is a measure to reduce the volatility of the price of the rupee in international markets by allowing banks to deal in off-shore non-deliverable pee derivative markets. It looks like reform using the crisis to bring about this long-awaited change.
RBI has come out all guns blazing trying to inject liquidity, nudge banks to lend and allow slack in loan repayments to deal with the economic pandemic caused by the microvirus that has brought the world to its knees. We don’t know if this is enough. But what is comforting is that the government and the RBI are working in tandem to deal with this giant killer of a virus.
Other than one earlier example, RBI governors are usually conservative in their speech and action. This governor is no different in his conservatism. For him to say “Yet, it is worthwhile to remember that tough times never last; only tough people and tough institutions do” is a big statement. It is confidence inspiring to a market, economy and household sector that is dealing with a never-before situation.
Monika Halan is Consulting Editor at Mint and writes on household finance, policy and regulation