How the Indian banking system works and money is created?
Why banks do lend their banking liquidity surplus money to RBI rather than their clients and why bank borrows money from RBI rather than clients deposits at the time of banking liquidity deficits?
- The RBI’s daily Liquidity Adjustment Facility (LAF) window merely allows banks to convert one form of statutory reserve to another
- If banks have CRR shortfall, then it can convert its excess SLR/HQLA into CRR on policy repo rate for this transformation
- In the same fashion, banks can convert their excess CRR into SLR/HQLA if they have shortfall on the policy repo rate
- Hence banks only have to take care of their total CRR and SLR/HQLA reserves requirements, which can be adjusted in case of anyone’s shortfall with LAF
How does the banking system fund fresh loans?
- When bank give loans, visually there is cash outflow for the bank but, the money goes to bank’s own deposit accounts
- If deposit holders withdraw that money, it will move in other banks account, which shows the beauty of the banking system as every disburse loan are creating their own deposits
Are there any funding constraints to lending?
- The indirect constrain here is reserve requirements
- Every time when bank disburse loan, it CRR and SLR need to shoot up and if bank has surpluses, there is no problem
- Another constrain is the need of bank capital which keep increasing with every disburse loans
Can banks alter banking liquidity?
- Actually, bank can’t alter banking liquidity, it can be done only by RBI in many ways
- When government pay taxes to RBI, banks’ deposits and CRR reduces, and when government spend money, it increases banks’ deposits and CRR
- Open market operation bond purchase by RBI decrease bank’ SLR/HQLA and increase CRR, conversely when RBI sell bonds, it decreases banks CRR and increase SLR/HQLA
- RBI can alter banking liquidity by changing minimum requirements of CRR and SLR/HQLA
- Hence, neither of these ways are controllable by banks
But can’t individual banks adjust their liquidity situation?
- Banks can adjust their own liquidity situation but can’t adjust situation of entire banking system, they only pass the surplus of deficits to other banks
- When banks have a liquidity surplus, they will purchase risk-free securities or disburse loans, which will not affect banking system liquidity but will lower short term rate of overnight funds and encourage lending
- When banks have deficits, they simply pass the deficit to another by selling securities and attracting deposits, which will increase short term rate and discourage fresh loans
What is TLTRO and why does it impact non-banking financiers?
- NBFCs have a problem as they are not getting repayments due to COVID 19
- RBI has offered three-month payment moratorium to all borrowers, even of NBFCs, which means many such people will not pay their monthly dues until after May
- NBFCs borrows money from the bank but the bank doesn’t provide any moratorium to them
- So, NBFCs are getting less money from borrowers and they have to repay regularly to banks
- NBFCs also have to pay for their bond payment as they can’t delay them
- NBFCs have a big amount of borrowed debt maturing near September
- Now how they will repay them?
- They have to use their cash reserves to do so and they can issue new bond or securities but there is no buyer of such securities in the current market
- So, RBI introduced Targeted Long-Term Repo Operations (TLTRO)
- Here, RBI is giving funds to banks on repo rate for 3 year and force banks to buy the bond of these NBFCs
- A bank can buy a maximum of 10% of allocated amount to one entity
- 50% of this amount has to be invested in fresh issue and rest in secondary market
- Banks can purchase bonds of any duration, and they have to repurchase them till TLTRO’s duration which is 3 years expire
- After 3 years, banks have to return money to RBI with interest
- Briefly NBFCs and corporates can issue new debt, will be bought by banks and they will able to repay their borrowings
- Mutual funds are also having redemption pressure and they are unable to sell securities in secondary market, but with TLTRO, banks will buy them
- But here banks have credit risk and RBI haven’t provided any guarantees of companies, so they started deploying money to high rated corporate as they want to play safe
- But the main intention is to help entities who are facing liquidity crunch
- So, RBI has started a version 2 of TLTRO and has asked the banks to specifically allocate to NBFCs only
- Under version 2, RBI come up with additional 50,000 crores for NBFCs only
- Minimum time to deploy the allocated funds has been extended from 30 days to 45 days
- All the 50,000 Cr should be used to buy bonds of NBFCs only, including housing finance companies
- From 50,000 Cr,
- 10% (Rs 5,000 Cr) – for Microfinanciers (MFIs)
- 15% – for NBFCs with asset size of Rs 500 Cr and below
- 25% – for NBFCs with asset size of Rs 500 Cr – Rs 5,000 Cr
- 50% – to be deployed any which way they choose
- No criteria for primary and secondary market
- No maximum 10% allocation for individual company rule
- But here, RBI allocated 15% which is 7,500 crores for NBFCs with asset size of 500 crores and below
- To deploy 7,500 crores in such NBFCs means banks have to lend to many NBFCs, so we can say it is higher amount to deploy
- There are 25,000 crores available for listed bigger asset size NBFCs, which may not be sufficient
- The problem of entire situation is there is no protection for banks against default of companies and thus banks are staying away even from strong NBFCs
The action of TLTRO may be good to create some liquidity for NBFCs but the risk available here is unignorable
Case study of Cliarant (forensic accounting)
- Cliarant India is a private company in India and Cliarant (Singapore) is its parent company
- This private company have some related party transactions with parent company like rental income
- Deepak Parekh is MD of listed company (describe in Cliarant- Singapore balance sheet) and also director in private company
- But when we see it on Cliarant- Singapore annual report, we can’t find Deepak Parekh as director of Cliarant India
- So here, we can conclude that they don’t want us to know that Deepak Parekh is director in both the companies
- From Dec. 2014, company’s share price is falling constantly
- If we were able to know this Deepak Parekh’s directorship, we would be able to sell the shares as this type of activities is happening here