Tag: Ecowrap

RBI may deflate hype around reverse repo rate hike: SBI report

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The Reserve Bank of India (RBI) may deflate the hype around reverse repo hike in the monetary policy by explaining the virtues of using reverse repo change as a pure liquidity tool and not a rate tool, according to State Bank of India’s economic research report “Ecowrap”.

It emphasised that delaying normalisation measures is prudent in the current situation which would also give time for economic recovery to strengthen further.

“We believe the talks of a reverse repo rate hike in the Monetary Policy Committee (MPC) meeting may be premature as the RBI has been largely able to narrow the corridor without the noise of rate hikes and ensuing market cacophony,” said Soumya Kanti Ghosh, Group Chief Economic Advisor, SBI.

Reverse repo rate is the interest rate that banks earn for parking short-term surplus liquidity with RBI.

Section 45Z (3) of the amended RBI Act of 2016 clearly states that, “The Monetary Policy Committee shall determine the policy rate required to achieve the inflation target”.

Ghosh emphasised that nowhere in the MPC’s mandate is there any reference to its role in liquidity management, which remains internal to the functioning of the Bank consistent with its policy stance. Thus, the RBI is not obliged to act on reverse repo rate only in MPC.

Unconventional tool

Also, change in reverse repo rate is an unconventional policy tool that the RBI has effectively deployed during crisis when it moved to a floor instead of the corridor.

In this regard, the report made a reference to Goodhart’s (2010) observations that the width of the policy corridor acts as an independent instrument for the central bank in a crisis and an asymmetric corridor is a logical outcome.

According to SBI’s economic research department, the central bank can (for whatsoever reason) supply any amount of additional liquidity without pushing short-term money market rates below the key policy rate.

“Thus, the interest rate can be set to achieve monetary goals, while the amount of liquidity in the banking system can play the role of financial market stabilisation. Since the pandemic, the RBI has done exactly this balancing act, and the pandemic is not yet over!” Ghosh said.

Referring to the US Fed indicating accelerating the bond tapering program, thereby ending it earlier than anticipated, the report observed that the rate hikes are also in offing sooner than expected as inflation is no longer considered as transitory.

“Unless Omicron proves more fatal than Delta variant, this in turn would imply strengthening of the dollar and depreciation pressures for the rupee. Thus RBI would have to look for multiple objectives,” the report said.

Ecowrap noted that the forthcoming monetary policy comes against the backdrop of the global scare of Omicron, that we are still trying to unravel.

However, the good thing is India has now vaccinated 125 crore people and this might have given the country better preparation for the future as the gap between the first and second wave was only 2 months.

“…The pandemic has also worked its way through the population resulting in larger herd immunity…” the report said.

Calibrated progress

Ghosh noted that the RBI has made a calibrated progress towards liquidity normalisation since the October policy with amount parked in overnight fixed reverse repo declining to ₹2.6 lakh crore from ₹3.4 lakh crore in pre-October policy

The lower increase in currency in circulation as more people are now using digital modes of payments has also contributed to the build-up of the surplus liquidity.

The report said the RBI has also largely achieved its objective of pushing up short term rates with 3 month T-Bill rate which was below reverse repo for major part of August now at 3.52 per cent, factoring in the impact of variable reverse repo rate. Similarly, 6 month and 1-year T-Bill rates have shifted upwards by 20-30 basis points since last MPC.

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Towards a level playing field in ‘Business Correspondent’ model of banks

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The Reserve Bank of India (RBI) should rationalise the interchange fees for Aadhaar Enabled Payments System (AePS) transactions and also disincentivise Business Correspondents (BCs) for unfair business activities to generate commission, according to State Bank of India’s economic research report Ecowrap.

This can ensure a level playing field in the BC model followed by public sector banks (PSBs) and other banks.

AePS is a bank-led model that allows online interoperable financial inclusion transactions at point of sale/PoS (micro ATM) through the BC of any bank using Aadhaar authentication.

BCs are retail agents engaged by banks to provide banking services at locations other than a bank branch/ATM.

How to make BCs more viable

PSBs mostly follow ‘branch-led BC model’, while other banks follow ‘branch less/ micro ATM/kiosk application on mobile/corporate BC model’ for financial inclusion.

Three key facts

The report underscored three facts — more than 77 per cent Pradhan Mantri Jan Dhan Yojana (PMJDY) accounts have been opened by PSBs; the number of BCs/customer service points (CSPs) of other banks largely outnumbered that of PSBs and, over the years, OFF-US transactions are increasing.

Data indicate that the share of AePS “OFF-US” transactions (where the card issuing bank and acquiring bank are different entities) in AePS increased from 4 per cent in September 2016 to 51 per cent in September 2021.

In AePS “ON-US” transaction, the card issuing bank and the acquiring bank are the same entity.

“Considering these facts, PSBs (that opened around 77 per cent of the PMJDY accounts) are now net payers of interchange fee. We estimate that the PSBs could be paying ₹600-700 crore per annum as interchange fee,” said Soumya Kanti Ghosh, Chief Economic Adviser, SBI.

He emphasised that since AePS works like a PoS, logically the ‘acquiring bank’ (the bank which has installed the PoS terminal at the merchant location) should pay the interchange fee to the ‘issuing bank’(the bank which has issued the card to the customer).

Alternatively, there could be rationalisation in interchange fee as there is no level playing field in infrastructure provided by all banks.

Holistic financial inclusion

With requisite savings, banks can further strengthen/upgrade their BC model and promote financial inclusion in a more holistic manner, the report said.

Currently, the account opening bank pays an interchange fee to the operator of the BC/ CSP when a customer makes a transaction at micro ATM that does not belong to the account opening bank (that is OFF-US transaction).

At present the interchange fee is 0.5 per cent of transaction amount (minimum ₹1 and maximum ₹15) for an OFF-US financial transaction and ₹5-7 for non-financial transaction.

The report noted that BCs convert AePS ON-US transactions of one set of bank customers to AePS OFF-US issuer transactions and also carry out multiple AePS ON-US and AePS OFF-US transactions on the primary bank application/software.

Women Business Correspondents: Agents of change in India’s financial inclusion

SBI’s economic research department cautioned that the ‘micro ATM/kiosk application on mobile’ model might also lead to several frauds as the mobile BCs introduce themselves as government persons and need biometric authentication to provide different types of subsidy.

PSBs, who are active in financial inclusion activities, have opened a large number of PMJDY accounts (out of 44 crore accounts, PSBs opened 34 crore accounts and non-PSBs 1.3 crore, rest RRBs) with minimal balance and thus incur recurring expenditure by way of servicing such customers, including issuance of free RuPay debit card, besides monthly remuneration for BC operations.

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Bank loans do not reflect credit risk adequately as RBI chases growth, BFSI News, ET BFSI

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The period of extended surplus liquidity is already witnessing fierce pricing wars across banks, some of which may not reflect credit risk adequately.

“However there is the risk of an Asset Liability mismatch if the liquidity is withdrawn quickly. As of now, the inflation numbers may not warrant such a decision from RBI, but if core inflation persists in the current range of 6% or above, that might act as a hindrance to continued liquidity abundance,” according to the State Bank of India’s economic research report Ecowrap.

The industry is replacing its long-term debts by very low-priced CP/working capital demand loan (ECDL) and this will obviously act as an enabler once the investment cycle revives

Margin pressure

Banks are now facing significant margin pressures despite surfeit of liquidity in the banking system, it said.

A back of envelope estimate suggests that the core funding cost of the banking system that includes cost of deposits, negative carry on Statutory Liquidity Ration (SLR) and Cash Reserve Ratio (CRR) and Return on Assets is currently at 6 per cent, while the reverse repo rate is at 3.35 per cent. Additionally, if the cost of provisions is added to the core funding cost, the total cost comes to around 12 per cent, the report said.

Credit risk

The report cited the example of 15 years loans, which are being priced at even lower than 6 per cent, linking with repo / treasury bill rates. It said that 10-year Government Security (G-Sec) is currently trading at 6.2 per cent and by the current pricing trends this could even gravitate towards 6 per cent again.

This anomaly not only negates the concept of tenor premium but may create a material risk with regard to sustainability of such rates in long term, on which borrowers and banks are basing their financial calculations, it said, adding that the only good thing is that such pricing war is mostly restricted to AAA borrowers.

According to the report, three year term loans are being quoted at close to 4 per cent repo rate and seven year term loans for borrowers below AAA are also quoting a risk premium of 15-20 basis points over the 10 year rates. Working Capital Loans (WCL) are currently being quoted at a notch above reverse repo rate at 3.35 per cent.

The report said that the concept of normally permitted lending limit (NPLL) for specified borrowers, meant to nudge them to move towards corporate bonds market, may lose its importance.

CP market

Ghosh observed that the commercial paper (CP) market is also witnessing significant churn with banks now almost absent.

Non-Banking participants like mutual funds who do not have access to RBI Reverse Repo window are creating pricing pressure in CP market as they are sometimes quoting below RBI reverse repo rate.

The CP market reflects the huge pricing gap between better and lower rated borrowers, it said.



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Banks face significant margin pressure despite surfeit of liquidity

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Banks are facing significant margin pressures despite surfeit of liquidity in the banking system, according to the State Bank of India’s economic research report Ecowrap.

A back of envelope estimate by SBI’s economic research department suggests that the core funding cost of the banking system that includes cost of deposits, negative carry on Statutory Liquidity Ration (SLR) and Cash Reserve Ratio (CRR) and Return on Assets is currently at 6 per cent, while the reverse repo rate is at 3.35 per cent.

Additionally, if the cost of provisions is added to the core funding cost, the total cost comes to around 12 per cent, the report said.

Also see: FinMin to soon issue circular on intermediary services under GST

“Clearly, banks are facing significant margin pressures. This apart, market sources point out that risk premia over and above core funding cost are not fairly acknowledging the inherent credit risk,” said Soumya Kanti Ghosh, Group Chief Economic Adviser, SBI.

The report said the conundrum of weak credit demand and excess liquidity is evident from the average reverse repo at ₹7 lakh crore since April and Government of India cash balances with RBI at ₹3.4 lakh crore.

Is credit risk adequately reflected in pricing?

The report cited the example of 15 years loans, which are being priced at even lower than 6 per cent, linking with repo / treasury bill rates. It emphasised that 10-year Government Security (G-Sec) is currently trading at 6.2 per cent and by the current pricing trends this could even gravitate towards 6 per cent again.

“This anomaly not only negates the concept of tenor premium but may create a material risk with regard to sustainability of such rates in long term, on which borrowers and banks are basing their financial calculations.

“The only good thing is that such pricing war is mostly restricted to AAA borrowers,” Ghosh said.

According to the report, three year term loans are being quoted at close to 4 per cent repo rate and seven year term loans for borrowers below AAA are also quoting a risk premium of 15-20 basis points over the 10 year rates. Working Capital Loans (WCL) are currently being quoted at a notch above reverse repo rate at 3.35 per cent.

Referring to RBI proposing the concept of normally permitted lending limit (NPLL) for specified borrowers, which is meant to nudge them to move towards corporate bonds market, Ghosh felt that this may lose its importance.

Also see: Hiring activity in August up 14% y-o-y: Report

In the current situation, corporate bond rate and bank lending rate are showing huge differential, he said.

CP market: significant churn

Ghosh observed that the commercial paper (CP) market is also witnessing significant churn with banks now almost absent.

“Non-Banking participants like mutual funds who do not have access to RBI Reverse Repo window are creating pricing pressure in CP market as they are sometimes quoting below RBI reverse repo rate.

“In fact, the CP market reflects the huge pricing gap between better and lower rated borrowers,” he said.

Asset Liability mismatch risk

The report underscored that the industry is replacing its long-term debts by very low-priced CP/working capital demand loan (ECDL) and this will obviously act as an enabler once the investment cycle revives. However there is the risk of an asset liability mismatch if the liquidity is withdrawn quickly.

Ghosh said, “As of now, the inflation numbers may not warrant such a decision from RBI, but if core inflation persists in the current range of 6 per cent or above, that might act as a hindrance to continued liquidity abundance.”

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Poor people rely more on post-offices for their savings: SBI report

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Post-Office savings deposits are negatively correlated to per capita income while bank deposits are positively correlated with per capita income, according to State Bank of India’s (SBI) economic research report “Ecowrap”.

This indicate that poor people are more reliant on post-offices for their savings and when the income increase they shift to bank deposits first and not to financial products,as per the report put together by SBI’s Economic Research Department.

“That’s why the proportion of post-office deposits in Maharashtra & Delhi, where per capita income is very high is only 60 per cent.

“In states with low per capita income like West Bengal, Uttar Pradesh, Rajasthan and Bihar, the elderly population of 60 plus has a clear preference to invest in post office saving deposits,”Soumya Kanti Ghosh, Group Chief Economic Adviser, SBI, said.

Referring to the trend of last 20 years data on gross small savings collections, the report noted that there is a structural break in 2008-09. In particular, the share of different states in gross small saving collections were declining till the global financial crisis.

However, post the financial crisis in 2008, there has been a significant jump in preference for post office savings. This jump is maximum in low income states like West Bengal and even in high income states like Maharashtra, the report added.

India Post Payments Bank app: The good, the bad and the ugly

Lack of financial literacy

Ghosh observed that the huge post-office collections in states like West Bengal and Uttar Pradesh and the preponderance of Kisan Vikas Patras indicate the lack of financial literacy for the products such as mutual funds.

“Particularly in West Bengal, sometimes, the left of political ideology that everything that market does is bad in fact results in asymmetric results with poor people investing more in chit funds, the live example of this is the ₹20,000-30,000 crore Saradha scam.

“Most of the times these types of scams are also the product of political dispensation,” Ghosh said.

He emphasised that the Government has taken the best decision of not changing the rates on small saving schemes as the country is currently going through an unprecedented pandemic crisis.

Lock into the Post-Office Senior Citizens Savings Scheme

Protecting seniors interest

To further improve the economic condition of senior citizens, the report recommended giving full tax rebate on the interest amount up to a threshold level on the Senior Citizens Savings Scheme (SCSS). This will have nominal impact on the exchequer.

Under SCSS, a senior citizen can deposit ₹15 lakh and the current interest rate is 7.4 per cent. However, the interest on SCSS is fully taxable (the interest amount for ₹1 lakh deposit for 5 years is around ₹51,000 which is taxable). The February 2020 outstanding under SCSS was ₹73,725 crore.

The report suggested that an age-wise interest rate structure should be ushered in, with rates linked to long-term bank deposit rates till a certain age group, and offering a higher than market rate over that age group.

“This could, in one go, serve the multiple purposes of ensuring a lower lending rate structure, adequate returns for senior citizens, lower interest expenditure and an alternative to floating rate deposits,” Ghosh said.

As Small Savings Scheme (SSS) rates are adjusted in every quarter, the report said the Government should ideally remove the 15-year lock-in period for Public Provident Fund (PPF) and give the investors the option to withdraw their money within a stipulated time with some sort of disincentive

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Rising G-Sec yields: SBI report warns of MTM losses for banks

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Any further upward movement in Government Security (G-Sec) yields, even by 10 basis points (bps) from the current levels, could usher in mark-to-market (MTM) losses for banks, cautioned State Bank of India’s economic research report ‘Ecowrap’.

SBI’s economic research team believes one of the reasons for the recent surge in yields might be short-selling by market players.

The report said the Reserve Bank of India will have to resort to unconventional tools, including speaking to market players/off-market interventions, open-market operation (OMO) in illiquid securities and penalising short-sellers, to control the surge in bond market yields.

“The average increase in G-Sec yields across three, five and 10 years is around 31 bps since the Budget.

“AAA Corporate bond and SDL (State development loan) spreads have jumped by 25-41 bps during this period,” said Soumya Kanti Ghosh, Group Chief Economic Advisor, SBI.

While this significant increase in bond spreads is a manifestation of the nervousness of market players, Ghosh believes the central bank will have to resort to unconventional tools to control the surge in bond market yields.

Since January-end 2020, the yield on the most traded 10-year G-Sec (the 5.77 per cent GS 2030) has gone up by about 28 bps, with its price declining by about ₹1.90. MTM losses require banks to make provision towards investment depreciation.

Ghosh opined this is important as any further upward movement in G-Sec yields, even by 10 bps from the current levels, could usher in MTM losses for banks that could be a minor blip in an otherwise exceptional year in FY21 for bond markets, with the RBI assiduously supporting debt management of the government at lowest possible cost in 16 years.

In fact, the RBI strategy of devolving on the primary dealers (PDs) may have its limitations as standalone PDs account for 15-16 per cent of secondary market share and this may not be enough to move the market, Ghosh said. This share has remained broadly consistent over long periods despite excessive market volatility.

Short-selling

While going short or long are typical market activities that aid in price discovery, in times, it can result in price distortions, too, as it might be happening now, the report said.

Ecowrap noted that the banks and the primary dealers resort to short-selling when their view is bearish — that is, the prices of the bond will fall and the yield will rise.

“They make money if the bond prices drop and yields rise, and over a point of time, this could become a self-fulfilling prophecy as such short-sellers keep on rolling over their borrowed security from the repo market till the time they believe that yields will continue to rise,” it said.

Ghosh felt that the only way to break such self-fulfilling expectations is for the RBI to conduct large-scale OMOs to provide necessary steam to the bond market to rally and with increase in price, many short sold position will trigger stop losses and market players will scramble to cover open positions. This will hasten a rapid fall in yields over a short period of time.

RBI steps

The report suggested that the RBI could announce steps including announcing a weekly outright OMO calendar of ₹10,000 crore till March-end, reducing the time period for covering short sale from 90 days to 30 days, and prescribing a margin requirement for borrowing securities in the repo market while covering the short-sale position to cool the yields.

It also recommended allowing more players such as mutual funds and insurance companies in the repo market and penalising short-sellers.

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