Bank Rate: Is It Relevant Now?-VRK100-23Jul2013

Rama Krishna Vadlamudi, HYDERABAD      23 July 2013
www.ramakrishnavadlamudi.blogspot.com

As the above graph illustrates, Bank Rate had been kept in comatose for almost a decade between 2003 and 2012. Suddenly, one fine morning in 2012 RBI rediscovered the Bank Rate and raised it by 350 basis points (or 3.5 percentage points) to 9.50 percent. Since then, it has been revised on five other occasions as shown in the above graph.  

The reactivation of Bank Rate since 2012 is broadly on the lines of the report (March 2011) of the Deepak Mohanty Committee on the operating procedure of the monetary policy. This article explores the relevance of Bank Rate in the context of monetary policy. 

What is Bank Rate?:

Informally, Bank Rate is the rate of interest charged by a central bank on the funds lent to banks. However, under Section 49 of the Reserve Bank of India Act, 1934, the Bank Rate has been defined as “the standard rate at which the RBI is prepared to buy or re-discount bills of exchange or other commercial paper eligible for purchase under this Act.” Bank Rate is essentially a discount rate.

Since its introduction in 1935, the Bank Rate was revised by RBI on 35 occasions till now. At present, the Bank Rate is 10.25 percent. (Bank Rate was 3.5 percent when it was first introduced in 1935). Bank Rate has been made equal to Marginal Standing Facility (MSF) rate since 13 February 2012 and so whenever the MSF rate is revised, the Bank Rate also gets revised.

Interestingly, the MSF Rate itself is linked to LAF-Repo rate, with a positive spread of 300 basis points (or 3 percentage points) over the Repo rate. So practically, Bank Rate changes whenever the Repo rate is revised by RBI or the spread between the Repo Rate and the MSF Rate is changed. Now, Repo Rate is the single policy rate used by RBI for setting interest rates (monetary management) in the economy. The current rates of RBI’s policy rates and reserve ratios are given below:

RBI’s Policy Rates				RBI’s Reserve Ratios
Rate	%	Effective		Ratio	%	Effective
		Date				Date
LAF-Repo	7.25	3-May-2013		CRR	4.00	9-Feb-2013
LAF-Reverse Repo	6.25	3-May-2013		SLR	23.00	11-Aug-2012
MSF	10.25	16-Jul-2013
Bank Rate	10.25	15-Jul-2013

To know more about MSF and LAF-Repo, just click:

1. Update on Marginal Standing Facility-20Jul2013

2. LAF Repo Rate: Single Policy Rate-23Jul2013

How was Bank Rate used by RBI in the past?

Bank Rate was used by RBI as a general instrument of monetary policy in the past though RBI had used various other instruments also—such as, statutory liquidity ratio (SLR), cash reserve ratio (CRR), selective credit control, open market operations (OMO), and prescribing interest rates on deposits and advances. RBI used to provide short-term funds to commercial banks at Bank Rate against the collateral of eligible instruments.

Bank Rate was also used as a reference rate for various standing facilities, such as general refinance and export refinance, provided by RBI to banks. Bank Rate acted as refinance rate at which liquidity was to be injected to banks and primary dealers (PDs). On a few occasions, it was used for exchange rate management. It was also used for charging penalties on banks for not meeting reserve requirements (CRR and SLR).

The Relevance of Bank Rate Now:

The importance of Bank Rate as an important instrument of monetary control has declined after the introduction of Liquidity Adjustment Facility (LAF) in June 2000 and RBI’s standing facilities to banks/PDs were completely delinked from the Bank Rate. Now, all the refinance facilities are provided at the LAF-Repo Rate, which has emerged as the single signaling rate for monetary policy.

RBI is required to buy or re-discount bills of exchange or other commercial paper at the Bank Rate as per RBI Act, 1934. Since discounting/rediscounting by the RBI has remained in disuse, the Bank Rate had become inactive for several years. Under the revised operating procedure of the monetary policy (since May 2011), the MSF rate has in many ways serves the purposes of Bank Rate as a discount rate.

On 13Feb2012, the Bank Rate was raised by 350 basis points and since then it has been made equal to the MSF Rate. This increase was a one-time technical adjustment by RBI to align the Bank Rate with the MSF Rate and was not to be viewed as a change in the monetary policy stance.

    

The role of Bank Rate is now limited to:

1. It is now used for calculating penalty on default in CRR and SLR requirements as required by Section 42(3) of the RBI Act, 1934 and Section 24 of the Banking Regulation Act, 1949, respectively

  2. The penal interest on shortfalls in CRR and SLR (depending on the duration of the shortfalls) are Bank Rate plus 3.0 percentage points or Bank Rate plus 5.0 percentage points

  3. It is also used by several organizations as a reference point for indexation purposes. For example, under Section 372A of the Companies Act, 1956, inter-corporate loans shall not be made at a rate of interest lower than the prevailing Bank Rate.

For all practical purposes, the Bank Rate has become irrelevant as an instrument of liquidity and monetary management.

Summary:

Over the years, the Bank Rate has had its years of glory and gross negligence. RBI had used it for a variety of purposes—in the process confusing the markets and other stakeholders about the relevance of Bank Rate in liquidity and monetary management. With RBI’s flip-flop on Bank Rate, vague signals were sent to the market. One hopes that in future RBI will follow a consistent policy on Bank Rate. 

Today, the Bank Rate largely plays a technical-but-limited role only. Its role is confined to penalties charged by RBI on banks for not maintaining SLR and CRR requirements. The importance of Bank Rate as a monetary policy instrument has waned after the introduction of LAF-Repo rate in June 2000.

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Notes: LAF-Repo Rate under RBI’s Liquidity Adjustment Facility (LAF) is the rate at which RBI lends overnight funds to banks; CRR – Cash Reserve Ratio; and SLR – Statutory Liquidity Ratio.

Reference: RBI Act, Deepak Mohanty Committee report, other RBI reports and www.mca.org.in.

Disclaimer: The author is an investment analyst and freelance writer. His articles on financial markets and Indian economy can be reached at:

http://ramakrishnavadlamudi.blogspot.in/ and www.scribd.com/vrk100

Update on Marginal Standing Facility-VRK100-20Jul2013

Rama Krishna Vadlamudi, HYDERABAD       20 July 2013
www.ramakrishnavadlamudi.blogspot.com

Indian rupee has been depreciating steeply against the US dollar ever since the US Federal Reserve has hinted at tapering its quantitative easing (QE3) programme. For the first time since its introduction in 2011, the Reserve Bank of India (RBI) has used its marginal standing facility (MSF) to control depreciation of Indian rupee against the US dollar. The measures initiated by RBI on 15 July 2013 to rein in rupee volatility are:

a). The MSF rate has been readjusted to 300 basis points (from the earlier 100 basis points) above the policy Repo rate under the Liquidity Adjustment Facility (LAF). As such, the MSF rate is raised to 10.25 per cent from 8.25 percent with effect from 16Jul2013.

b). Accordingly, Bank Rate has been raised to 10.25 percent with effect from 15Jul2013 (since 13Feb2012, Bank Rate has been made equal to MSF rate)

c). With effect from 17Jul2013, the total amount under RBI’s LAF is restricted to one percent of the net demand and time liabilities (NDTL) of the banking system, reckoned as Rs 75,000 crore

d). RBI would sell government securities to the tune of Rs 12,000 crore on 18Jul2013 as part of its open market operations (OMO)

What is Marginal Standing Facility (MSF)?

The MSF was started by RBI during the Annual Policy statement announced by it on 03 May 2011. The MSF facility was made effective from 09 May 2011.

The marginal standing facility is an additional window provided by RBI to banks, so that the latter can borrow overnight funds from RBI against their excess SLR (statutory liquidity ratio) holdings. MSF scheme is similar to LAF-Repo scheme. The difference between MSF and LAF-Repo is that under MSF, banks will have to pay higher rate of interest to RBI for their borrowings as compared to LAF-Repo.

Banks will look for the MSF window to borrow money from RBI once they exhausted all other avenues (like, call money market, LAF-repo window, Collateralized Borrowing and Lending Obligation or CBLO, market repo, etc.) for overnight money. Under exceptional circumstances, banks will borrow money through MSF window.

What are the Salient Features of MSF?

1. The Objective of MSF:

This facility is expected to contain volatility in the overnight inter-bank money market.

2. Eligibility:

All scheduled commercial banks (SCBs) are eligible to borrow from RBI under MSF.

3. Tenor and Amount:

With effect from 17Apr2012, Banks can borrow overnight funds up to two percent of their NDTL. In general, the borrowing is for one day except on Fridays when the facility will be for three days. Banks can continue to access the MSF even if they have excess SLR holdings. (Prior to 17Apr2012, banks were allowed to borrow funds up to one percent of their NDTL under MSF).

4. Rate of Interest:

With effect from 16Jul2013, banks under MSF have to pay interest at the rate of 300 basis points or three percentage points above the LAF-Repo rate. At present, LAF-Repo rate is 7.25 percent and as such, the MSF rate is 10.25 percent. So, whenever LAF-Repo rate is revised by RBI, the MSF rate will be revised accordingly. Prior to 16Jul2013, MSF rate was linked to 100 basis points above LAF-Repo rate.

5. Minimum Size:

Under MSF scheme, banks will have to make requests for a minimum of Rs one crore and in multiples of Rs one crore thereafter.

6. Eligible Securities:

They are Government of India Dated Securities/Treasury Bills and State Development Loans (SDL).

7. Margin Requirement:

A margin of five percent is required for GOI Dated Securities and Treasury Bills; and for SDLs, it is 10 percent. So, banks will have to offer Rs 105 (face value) worth of GOI Dated Securities and Treasury bills for a request of Rs 100; and Rs 110 (face value) worth of SDLs for a request of Rs 100.

MSF Rates since Beginning:

Graph showing the MSF rates since inception:

Special Repo Window for Mutual Funds:

RBI had on 17Jul2013 provided a special repo window whereby banks can avail funds from RBI to meet the liquidity requirements of mutual funds. Under this special repo window, banks can avail liquidity assistance from MSF up to 0.5 percent of NDTL, which is over and above the two percent (of NDTL) regular MSF window. This additional limit of 0.5 percent of NDTL will be available for a temporary period till further notice.

Off-beat Move by RBI:

By increasing MSF rate to curb rupee volatility, the RBI has acted in an off-beat manner to the surprise of market participants. Though the stated objective of RBI in raising MSF rate is to address exchange rate volatility, the market participants have interpreted the measure as raising short-term interest rates. The bond markets have panicked and bond prices have fallen sharply with bond yields shooting up much to the chagrin of investors. In the equity markets, banking stocks have fallen steeply due to liquidity squeeze and Treasury losses from bond portfolios.  

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Reference: RBI

Disclaimer: The author is an investment analyst and freelance writer. His articles on financial markets and Indian economy can be reached at:

http://ramakrishnavadlamudi.blogspot.in/ or www. scribd.com/vrk100


Note: Please check the comment attached below, made on 05Dec2018 by me, for interest rate on MSF, which is now 25 basis points above the LAF Repo rate.

What is Marginal Standing Facility or MSF-VRK100-05Oct2011

Update on MSF dated 20Jul2013 is available at:

http://ramakrishnavadlamudi.blogspot.in/2013/07/update-on-marginal-standing-facility.html

What is Marginal Standing Facility (MSF)?

The Marginal Standing Facility was started by the Reserve Bank of India during the Annual Policy announced by it on 03 May 2011. Banks can now borrow overnight from the RBI’s MSF window up to one per cent of their respective net demand and time liabilities or NDTL.

This is an additional window and the interest rate is more expensive compared to repo rate under liquidity adjustment facility (LAF). The rate of interest on amounts accessed from this facility will be 100 basis points (or one per cent) above the repo rate. At present, the MSF rate is 9.25 per cent.

Banks will look for the MSF window to borrow money from RBI once they exhausted all other avenues (like, call money market, LAF-repo window, CBLO, market repo, etc.) for overnight money. Under exceptional circumstances, banks will borrow money through MSF window.

RBI Raises Interest Rates-VRK100-16Sep2011

RBI Raises Interest Rates

Mid-Quarter Monetary Policy of September 2011

As expected by the markets, the Reserve Bank of India has raised interest rates by another 25 basis points (0.25 per cent). The policy rate, that is Repo rate under RBI’s Liquidity Adjustment Facility, is increased to 8.25 per cent. Since March 2010, RBI has hiked interest rates by 350 basis points and that too twelve times in succession. However, markets had expected that RBI would tone down its stance on dear money policy. In its latest review, RBI has continued with its hawkish stance.

Despite several rate hikes, the inflation rate – close to 10 per cent now – has continued to be stubborn even though GDP growth and industrial production growth are slowing down. What is complicating matters for RBI is yesterday’s decision by the Government of India to hike retail petrol prices by Rs 3.14 per litre – this is the third hike in retail fuel prices in this calendar year. The question on everyone’s mind is whether RBI will stop raising interest rates further. The RBI will be watching the macro economic indicators and global developments closely before making further moves on policy rates.

RBI Policy Decision

The Repo rate (under its Liquidity Adjustment Facility or LAF) is the benchmark policy interest rate for the RBI. The RBI has raised its Repo rate by 25 basis points (0.25 per cent) to 8.25 per cent when it announced the mid-quarter monetary policy on 16 September 2011. The new rate is with immediate effect. The Reverse Repo rate under LAF and the interest rate under Marginal Standing Facility are linked to Repo rate. As such, both the Reverse Repo rate and Marginal Standing Facility rate stand increased to 7.25 per cent (one per cent below Repo rate) and 9.25 per cent (one per cent above Repo rate) respectively with immediate effect.

Twelfth Rate Hike Continuously

Since March 2010, RBI has been increasing the interest rates continuously and the latest increase is twelfth in the series. The RBI’s Repo rate hikes started from 4.75 per cent and the rate is now at 8.25 per cent, an increase of 350 basis points. In the last decade, the highest Repo rate was 9 per cent that existed from the end of July 2008 till September 2008 when Lehman Brothers collapsed.

Date	20-Mar-2010	20-Apr-2010	3-Jul-2010	27-Jul-2010	17-Sep-2010	2-Nov-2010
Rate %	5.00	5.25	5.50	5.75	6.00	6.25
Date	25-Jan-2011	17-Mar-2011	3-May-2011	16-Jun-2011	26-Jul-2011	16-Sep-2011
Rate %	6.50	6.75	7.25	7.50	8.00	8.25

Source: RBI

Rationale for Rate Hikes

What is the rationale behind RBI’s latest increase in rates?

v     Inflation rate of 9.8 per cent (for the month of August 2011 based on wholesale price index-WPI) remains at highly elevated levels for the past 11 months due mainly to high commodity prices and supply chain bottlenecks

v     This calendar year, fuel prices have been increased by Government of India three times. Retail petrol prices have been increased by Rs 8 per litre in the last four months. The impact of the fuel price hike is yet to play out fully in the economy.

v     Non-food manufactured goods prices too are rising

Impact

The present rate hike from RBI is on the expected lines. However, it was expected by the markets that the RBI would change its policy stance. Contrary to expectations, there is no change in RBI’s hawkish monetary policy. The stock markets were one per cent up seconds before the RBI’s rate hike. As soon as the RBI hiked the repo rate, the markets had suddenly collapsed and went into negative for a few minutes. But, later they recovered from their low levels and at the time of writing, the Sensex is at 16,990 and the Nifty is at 5,100.

The bond market too reacted negatively, though in a mild manger, to the RBI rate hike. Seconds after the RBI rate hike, the yield on the benchmark 7.80 per cent 10-year Government of India security maturing in 2021 is quoting at around 8.36 per cent from the old level of 8.32 per cent. Overall, the outlook for bond market is negative.

Banks will wait for some time to raise either deposit or lending rates – though one cannot rule out the possibility of some private banks raising interest rates immediately. Depending on liquidity conditions and various other factors, Banks will wait for some more time before taking the plunge. The overall impact of relentless increase in interest rates will be negative for the stock market as well the bond market.

Outlook on Further Rate Hikes

The macro economic indicators are presenting a mixed picture as of now. The first quarter GDP (April-June 2011) growth is at 7.7 per cent, showing a continuous decrease for the last six quarters. The Index of Industrial Production for July 2011 indicates that the overall industrial production has recorded a growth of 3.3 per cent, which is the lowest in 21 months. The investment cycle too has slowed down. The GDP estimates and IIP figures are clearly indicating that the growth rate in India is slowing down.

On the contrary, the inflation rate remains at elevated levels. Food inflation too is not under control. The Government of India has raised fuel prices three times in the current calendar year. The higher fuel prices are feeding into inflation figures. The inference is that RBI wants to keep its primary focus on inflation control despite signs of GDP growth slowing down. RBI continues with its current hawkish stance.

However, the apprehensions regarding the effectiveness of monetary policy in containing growth-induced inflation remain unanswered at this point of time. But, RBI claims that its rate hikes are having some impact on inflation, though not up to their expectations. Inflation seems to have been caused more by supply chain bottlenecks, substantial increases in personal wealth and huge Government spending in the last three to four years.

The subsidy burden of diesel, LPG and kerosene is too heavy for the Government and to keep the fiscal deficit under control, it is raising fuel prices as India imports 82 per cent of its crude oil needs. It will take some more time for the fuel price to fully reflect in inflation figures. There is no significant cut in Brent crude oil prices in the last three months and the outlook for crude oil prices remains hazy. The Government’s disinvestment programme is in a limbo as it is not able to raise any money through selling of small stakes in government companies. Due to weak market conditions and doubts about getting attractive issue price, the Government has now postponed the stake sale in ONGC, the public sector oil company.

The monsoon is good till now and is expected to be normal this year. However, what needs to be emphasized is that RBI will be keenly watching the important data, like, inflation, GDP growth, IIP numbers, fiscal deficit, crude oil & other commodity prices, global cues especially from the crisis-ridden euro zone and others before making further moves on its fight against inflation monster.

Important Terms Explained

Repo rate: The overnight rate at which banks borrow money from RBI by pledging                  Government securities with RBI

Reverse Repo rate: The overnight rate given by RBI to banks when the latter keep                     their surplus funds with RBI (one per cent below Repo rate)

Marginal Standing Facility (MSF): Banks can borrow overnight from the RBI’s MSF                            up to one per cent of their respective net demand and time liabilities or                        NDTL. The rate of interest on amounts accessed from this facility will be            

                 100 basis points (one per cent) above the repo rate.

LAF  – RBI’s Liquidity Adjustment Facility

RBI   – Reserve Bank of India

GDP  – Gross Domestic Product or national income

IIP     – Index of Industrial Production

Disclaimer: The author’s views are personal. He has a vested interest in the stock markets and his views should be taken with a pinch of salt. He may change his views very fast without any notice depending on the market and economic conditions. His views should not be construed as investment recommendation. There is a risk of loss in equity investments. Investors need to consult their certified financial adviser before making any investment decisions.

Note on author: The author in an investment analyst and writes copiously on financial markets – equities, bonds, currencies, taxes, Indian economy, etc. You can read these articles on:

www.ramakrishnavadlamudi.blogspot.com

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RBI Monetary Policy - Mid-Quarter Review of June 2011-VRK100-17062011

RBI Monetary Policy

Mid-Quarter Review of June 2011

Rama Krishna Vadlamudi, HYDERABAD June 17, 2011

As expected, the Reserve Bank of India has raised its benchmark Repo rate (under its Liquidity Adjustment Facility or LAF) by 25 basis points to 7.50 per cent when it announced the mid-quarter monetary policy on June 16, 2011. The new rate is with immediate effect. The Reverse Repo rate under LAF and the interest rate under Marginal Standing Facility are linked to Repo rate. As such, both the Reverse Repo rate and Marginal Standing Facility rate stand increased to 6.50 per cent (one per cent below Repo rate) and 8.50 per cent (one per cent above Repo rate) respectively with immediate effect.

Since the beginning of year 2010, RBI has been increasing the interest rates continuously. The latest Repo rate hike is tenth increase since March 2010 when RBI increased Repo rate from 4.75 per cent to 5.00 per cent – the cumulative increase in Repo rate amounts to 275 basis points (or 2.75 per cent) in the last 15 months.

Rationale

What is the rationale behind RBI’s latest increase in rates?

 Inflation rate of 9.1 per cent (provisional figure) remains at highly uncomfortable levels due mainly to high commodity prices

 Non-food manufactured goods prices have gone up in May 2011 in addition to higher inflation of food articles

 Manufacturers are passing on the increase in wage cost and service cost to consumers as is evident in the inflation indices

 Private consumption is at higher levels even though there is some deceleration in some sectors, like, automobiles

Impact

The present rate hike from RBI is on the expected lines. The stock market as well as the bond market has weakened considerably well before the announcement of the RBI’s rate hike. In its Annual Policy announced on May 3rd this year, RBI raised the Repo rate by 50 basis points in one go. After the Annual Policy announcement, commercial banks were quick to increase their lending rates suggesting strong monetary policy transmission, which indicates the ability of the RBI to pass on its policy initiatives to the broader economy.

On June 16, 2011, the benchmark Sensex closed at 17,986 down 0.81 per cent over the previous day’s close and the Nifty was down at 5,397. The downtrend is likely to continue till the next policy announcement by RBI. One can expect Sensex to drift down another 10 per cent from the current 18,000-level.

The bond market too had been reacting negatively in the last six weeks or so to the expected increase in RBI rate hikes. The benchmark 7.80 per cent 10-year Government of India security maturing in 2021 was showing signs of weakness till the policy announcement yesterday. But, after the rate hike announcement mid-day, the bond prices have gone up and the benchmark paper’s yield declined to 8.30 per cent from 8.38 per cent the previous day (bond prices move in opposite direction to bond yields). The future for Government bond prices looks weak now.

Commercial banks have been enjoying good net interest margins. As such, they may absorb some of the present rate hike themselves while some portion of the burden will be passed on to borrowers. Banks may increase their deposit rates also depending on the credit offtake. Overall, borrowers can expect rate increases in home loans, car loans, coporate loans, etc. This in turn will adversely affect domestic consumption.

Outlook

It is not clear whether the RBI’s actions in the last 15 to 18 months have been able to contain inflationary expectations even as GDP growth rate has moderated to 7.8 per cent in the January-March 2011 quarter from 9.4 per cent in January-March 2010 quarter. There is visible slowdown in manufacturing as indicated in the Industrial Index of Production (IIP). In the month of April 2011, IIP is at a sober level of 6.3 per cent. However, the apprehensions regarding the effectiveness of monetary policy in containing growth-induced inflation remain unanswered at this point of time.

Diesel price may be increased by the Government as the fiscal deficit may go out of control this year due to higher cost of imported crude oil. The subsidy burden of diesel, LPG and kerosene is too heavy for the Government. The liquidity situation seems to be comfortable now. Credit growth is around 21 per cent year-on-year above the RBI’s indicative projection of 19 per cent. The monsoon is most likely to be normal this year providing some hope on the food inflation front.

With stock markets languishing in sideways to downward trend, it remains to be seen whether the Government will be able to go ahead with its disinvestment programme. If it fails to raise additional money through disinvestment, its hold on the fiscal situation will deteriorate leading to higher fiscal deficit. Higher fiscal deficit may translate into higher interest rates in future. If the Government increases diesel prices, it may further accentuate inflationary expectations in the economy.

The financial markets have been expecting another rate hike of a minimum of 50 – 75 basis points before the end of this fiscal year. However, what needs to be emphasized is that RBI will be keenly watching the important data, like, inflation, GDP growth, tax collections, disinvestment of public sector companies, oil prices, global cues, and others, before making further moves on its fight against inflation monster.

In the last 15 months, RBI has been increasing interest rates as per market expectations as inflationary pressures have been building up in the economy. But the same cannot be said for the future RBI’s moves on interest rates. Next time, we need to expect the unexpected from RBI. Even though many experts and analysts have been expecting 50 to 75 basis points increase, we need to keep our fingers crossed and keep a close eye on data.

Repo rate: The overnight rate at which banks borrow money from RBI by pledging Government securities with RBI

Reverse Repo rate: The overnight rate given by RBI to banks when the latter keep their surplus funds with RBI (one per cent below Repo rate)

Marginal Standing Facility (MSF): Banks can borrow overnight from the RBI’s MSF up to one per cent of their respective net demand and time liabilities or NDTL. The rate of interest on amounts accessed from this facility will be 100 basis points (one per cent) above the repo rate.

LAF – RBI’s Liquidity Adjustment Facility

RBI – Reserve Bank of India,

LPG – Liquefied Petroleum Gas

GDP – Gross Domestic Product or national income

IIP – Index of Industrial Production

Disclaimer: The views of the author are personal.

The author writes copiously on financial markets – equities, bonds, currencies, taxes, Indian economy, etc. You can read these articles on:

www.scribd.com/vrk100

or

www.ramakrishnavadlamudi.blogspot.com





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