The Reserve Bank of India has cut the Cash Reserve Ratio (CRR) for banks, as a percentage of deposits, to 5.5% from the earlier 6%.

This is, they say, to manage the liquidity situation, where banks have been borrowing a lot (1.2 lakh cr. last) from the repo window; this is much more than the usual figures of 40-60,000 cr.

The repo rate remains at 8.5% and the reverse repo at 7.5%.

Banks are up more than 3% over this move, which gives them some headroom in terms of having to borrow less from the repo window. Analysts have said that the increase in 32,000 cr. of “reserve” money in the hand of banks will result in a multiplier effect (lend and take that money as a deposit, lend again, and so on). A multiplier of 5 will result in credit growth of 160,000 cr. which is huge.

But I doubt that, because NPAs are growing as well. In the last couple of quarters, NPAs have gone up 0.5% (till September), and another 0.5% will negate the entire impact of the CRR cut.

More importantly, the sectors in trouble are priority sector (mostly SMEs?) and Agriculture, where defaults are running at 5%. And the above chart is not including the massive restructuring of the Air India debt, the upcoming issue with Kingfisher, the large debt of GTL and then the many infra projects that are currently in limbo. (Since the chart is only till September).

Liquidity easing may just be a front – the real impact of the CRR cut will be that banks will have the cash to provision against more defaults. It is unlikely to create more lending. Recently, credit growth has dipped below deposit growth – another chart from RBI – for the first time since early 2010.

These are interesting times, no doubt. Combine it with a thorn in Greece that is threatening Europe and we find that things are much in flux.

In an attempt to unravel what’s happening with liquidity in India, let me explain a new concept called the Marginal Standing Facility (MSF).

When you deposit money in a bank, it has to keep 6% of that money as a reserve called Cash Reserve Ratio (CRR) against withdrawals by depositors as a whole. It also has to put 24% in Government of India bonds as a “Statutory Liquidity Ratio” (SLR) requirement. The rest it can lend out.

Usually banks buy excess SLR-able bonds, maybe upto 28% of deposits. The excess they can use to generate quick liquidity if they so desire.

To meet liquidity requirements, banks get to borrow from the RBI, with auctions conducted everyday for overnight (or over weekend) borrowing. This is called “repo” – or “repurchase” operations, where banks borrow overnight from the RBI and place, as collateral, the excess SLR securities. This happens currently at 8.5% per annum, but repo rates change.

Now the operation is conducted as a sell-repurchase operation – so the RBI actually buys the security from the bank, but the bank is forced to buy it back at a higher rate (the rate differential is at the 8.5% annualized rate for the period borrowed).

What happens if banks don’t have any excess SLR bonds, but are desperate for some cash? This has happened in the early part of 2011, when the RBi started to conduct TWO repo auctions per day instead of one, and relaxed SLR requirements. (They are called LAF auctions, or “Liquidity Adjustment Facility”. Don’t ask.)

To avoid this – since the SLR is in a  way a sacrosanct figure – the RBI introduced the Marginal Standing Facility or the MSF. I call this “despo” borrowing, since it’s done just like Repo except:

a) it comes at 9.5%, not 8.5% (a full percentage point higher than repo).

b) banks must place GOI bonds as collateral. But if they do that, since it’s a sell-and-repurchase operation, the bank will not own the GOI bond after the auction (it’s sold to the RBI). Which means it will violate SLR requirements of 24% of deposits. But if used for the MSF, the RBI allows the bank a relaxation of SLR limits. This relaxation is only upto 1% of the deposit base of the bank; above that is still subject to RBI penalties.

Now banks don’t pay 9.5% unless they are in a liquidity crisis, have maxed out repo and can’t access the call money markets. Then, the MSF borrowing is used, but is a sign of stress: that’s why it is “despo” borrowing. RBI reveals MSF figures every day in a press release marked “Money Market operations).

The RBI is the lender of last resort – that MSF is being used indicates that banks really need money, and they can’t get it from depositors (perhaps depositors are withdrawing money in large numbers – like for advance tax payments) Banks can’t generally go to people they have lent money and say give me back the loan earlier than its term, so they use the RBI facility like repo, and failing that, the MSF,  to tide over any intermittent demands for money.

(The reason I write about it is that the MSF, after being unused for so long, has suddenly started seeing action, starting with 1,000 cr. earlier this week to 6,000 cr. today. More on this later.)

RBI has deregulated the interest rate on NRI deposits of one year or more.

There are some ridiculous definitions for NRIs – they have to deal with “NRE”, “NRO”, “FCNR” and such crap. What you need to remember is that some of the deposits can be taken back, or “repatriated”, in dollars – the others stay in rupees in India. NRE is converted to rupees and interest is paid on it, and returned Why the difference? Because India doesn’t have a convertible currency and loves to play a bureaucratic game.

The rates on such deposits were highly regulated to N percentage points above LIBOR. Now the rate has been left to the banks. Current rates are less than 4%. NRE and NRO accounts are exposed to interest rate risk – if the rupee depreciates, they have to buy back dollars during repatriation at a much higher rate. (NRE deposits pay no Indian taxes on the interest)

There is $52 billion in non resident deposits (around Rs. 275,000 crore) which is about 5% of the banking system’s deposit base of 52 lakh crore. An increase in such inflow will help the rupee.

Sadly, the one-year exchange rate hedge is at around 55.36 (in the currency derivatives marke

Federal Bank – a Kerala based bank that should see inflows from the middle east – has already raised the NRI deposit rate from 3.82% to 6.5%. With the tax waiver the rate is close to a high-tax-bracket Indian deposit.

Update:  Karnataka bank now offers NRE deposits at 9.75%.

My take: What a crock of shit this rule was, and is. Indians abroad can send money home but not take it back easily. We restrict interest rates banks pay on such deposits, even when we saddle them with the risk on the exchange rate. We don’t let foreign individuals (other than those resident) even open rupee accounts, even when we are quite in need of inflows. We classify people as NRIs, FIIs, PIOs and other labels which make no sense when we desire their dollars. I hope this entire system is broken down and we can just call people “investors” regardless of country, colour or creed.

The Reserve Bank of India (RBI) today changed nothing, which nowadays is a big event in the markets.

In the mid-quarter policy review, RBI has said a lot of things.To simplify:

The Global Economic Situation is horrible. The outlook is bad, and other countries in Asia have seen both currency depreciation and policy rate cuts.

Indian growth is definitely down. They quote the IIP (-5.1% in Oct), the de-growth in GDP (6.9% in Q2 FY12 versus 8.6% last year), the HSBC PMI that’s shown some contraction. (I have graphs for everything)

Inflation is still bloody high. November 2011 Inflation was at 9.11%, above the comfort level of the RBI.

The rupee has fallen a lot, and the RBI has taken steps to attract inflows: Increasing limits on investment in govt. and corp debt, raising ceilings on NRI deposits, and increasing the ceiling on corporate borrowings abroad.

The Fiscal Situation is terrible. The deficit is likely to fuel inflation further.

Non-food credit growth is 17.5%, which is lower than expected growth of 18%.

There is no liquidity crisis, even though banks are borrowing around 90K cr. from RBI overnight through repo every day. The MSF (Marginal Standing Facility) remains unutilized – it’s at a 9.5% rate. OMO purchases of GOI bonds are likely to continue, to ease some the liquidity issues, but there’s no real stress.

What is significant:

While inflation remains on its projected trajectory, downside risks to growth have clearly increased. The guidance given in the SQR was that, based on the projected inflation trajectory, further rate hikes might not be warranted. In view of the moderating growth momentum and higher downside risks to growth, this guidance is being reiterated. From this point on, monetary policy actions are likely to reverse the cycle, responding to the risks to growth.

Perhaps they will cut rates in the next review – if by that time the rupee hasn’t hit 60 or something.

Rates:

Repo Rate: 8.5%.
Reverse Repo: 7.5%
Cash Reserve Ratio: 6%
Statutory Liquidity Ratio: 24%

If you want an explanation of these terms, let me know.

It’s nickel-and-dime time again, folks. HDFC Bank will now charge for anything if you snoop around their branches, so don’t step in to say hi to that friendly branch manager any more.

New charges have been introduced on inactive accounts (no “customer initiated transaction in one year”).

• And IPIN or TPIN changes at the branch will cost you Rs. 50,
• you get charged higher for non maintenance of average “monthly” balance (note: moved from average “quarterly” balance)
• No more fixed deposit in lieu of a balance – that facility is gone. So if you have a deposit, withdraw it immediately
• Huge ECS (Debit) return charges of Rs. 350 to Rs. 750
• If you deposit a cheque and it come back unpaid, take a hit of Rs. 100.
• Limits on cash transactions to 5 per month – I wonder if this includes ATM usage
• Duplicate statements, Address confirmation, PIN regeneration  cost Rs. 50 to Rs. 100 each.
• Want to close your account? You’ll get docked Rs. 500 (Wow!).

Rs. 500 to close an account? This is usury and I hope they get taken to the RBI ombudsman for it. But yes, this does mean I’m thankful for opening an account with Yes Bank and that I will get to opening an account with SBI as well. Then I’ll move the money over to whoever charges me the least, while maintaining multiple accounts.

This could be a precursor to higher SB account charges, but we’ll only know on Jan 1, I imagine.

I wonder if this is the end of the great HDFC Bank Bull Run (in the stock market). The stock has outperformed everything but the competition from the likes of Axis, Kotak, Indusind and even SBI will make it difficult to survive through heavy fees. The 45% CASA ratio is sure to change; a new kind of regime will need to set in, soon.

Today’s Chart includes the volumes in NEFT (National Electronic Fund Transfer) – Credits and Debits.

Turns out that the highest outward debitter isn’t the mammoth SBI, but HDFC Bank. That could be because it’s the bank of choice of brokers and exchanges. Citi was another surprise there.

On the Credit side, SBI takes the top spot, with HDFC second and ICICI a distant third.

The top 10 entries are more than 60% of total volumes. The rest of the public sector bank pack only appear beyond the #10 zone, which is perhaps reflective of the kind of customers they have (rural customers and non corporates generally don’t use NEFT that much).

Sorry for the lack of posting. I had a computer problem that took time solving.

The Reserve Bank of India will buy 10,000 cr. of bonds in an OMO auction on Nov 24 (an Open Market Operations auction between RBI and Banks/PDs who offer bonds to RBI, in return for money). RBI prints the money to pay for the bonds, so in effect it is an “increase” in reserve money (M0).

The increase in interest rates has started to hurt liquidity. Banks have been borrowing heavily from Repo every day from the RBI (more than 100,000 cr. per day recently). This has not quite reflected in the Commercial Paper/Certificate of Deposit market – those rates (where banks borrow for periods<1 year) are still less than 10%. But you can bet that it will once banks exhaust the govt bonds they own, since Repo is only against the security of such SLR securities. Still, it indicates that the liquidity crunch is not yet very deep.

Second, Government bond auctions have been devolving since October. That means there simply aren’t enough bids, so the underwriters have to buy them instead. This has been getting worse, with the RBI increasing the cut-off yield to accomodate more bids but they still tend to devolve. To the extent that the entire 2017 – a six year bond – auction was cancelled last week due to weak bidding. Even a new 13 year bond went in at 9.15% yield. (Much higher than expected)

Note: This is the yield for 2 payments a year. If you do an APR – that is, compare it to an instrument that pays interest once a year – the yield is probably 10-20 bps higher. Thanks to reader Sam for that input.

With an increasing fiscal deficit the government has no choice but to borrow, but if banks have a liquidity crunch, they will not go around trying to buy bonds instead. So the RBI is buying bonds from the banks to ease that pressure.

Is buying bonds the solution? Yes, it will solve the issue of the government being able to sell more debt – though indirectly since RBI can’t directly buy govt. bonds, it will only buy them from banks and other holders. But it stokes inflation and inflation is one serious problem. We’ve raised rates 13 times just to control inflation – and when money supply finally seemed to be slowing, we end up increasing it.

We also don’t know if this is a credit crisis yet. The failures of large companies, if it happens with the likes of Kingfisher or the FCCB borrowers, will create defaults and contract money-supply (“deleveraging”) for which the RBI action to buy bonds will seem justified. All countries are now doing the money-printing thing to stave of crises, even if it will create inflation later. Given that we don’t have a crisis yet, and we have high inflation, I’m not sure why we are starting the printing presses. Is there something the RBI is trying to tell us, by their action?

Be very prepared.

…and the bank index fell nearly 3% yesterday.

Moody’s, which is a rating agency and therefore likely to be completely clueless, took the Indian banking system down from “stable” to “negative”, because they believe loan quality will suffer in the near future.

This doesn’t matter much, despite the one day reaction, because no one cares for ratings anyhow, and everyone knows Indian banks are likely to be a better bet than most European banks today.

In the evening, the US markets tanked over 3%, taking with them $IBN (ICICI bank) which fell 8%, $HDB (HDFC Bank) which was down 7%. India has a holiday today so we won’t know the impact till tomorrow.

Are banks in bad shape? Not right now.

There are some issues with what are “Innovative Perpetual Debt Instruments” (IPDIs) which are basically debt but for some obscure reason banks were allowed to recognize as equity (Tier 1 capital). In my view, you can’t have debt as equity because, well, it’s frikking debt, dammit. The amount a bank can borrow or lend is a multiple of its capital – so if it borrows to augment its capital…you get the picture.

Basel III norms – not yet adopted – will remove IPDIs from Tier 1 capital requirements. SBI, for instance has more than 6,000 cr. in IPDIs, with a total Tier 1 capital (including IPDIs) of 85,000 cr. That, they say, is equivalent to a capital adequacy ratio of around 7.5% – and without the IPDIs will come down by another 0.5% or so. This is not too bad, but it’s borderline low at 7%, which are what Basel III prescribes as a lower limit.

Still, most bank statistics have elements of shadiness in them, worldwide. Inaccurately marked debt, not enough provisioning for a bad loan, overvalued collateral, etc. With a stress factor in the system – higher rates – there is potential for default, and now with Europe in turmoil, there is even more damage likely to a leveraged institution such as a bank. These are factors that make it negative for Indian banks (as well as banks worldwide) .

But at this point, to say that we are worse than, say, Italian banks (which is what Moody’s is saying), is to be lacking in the neuron department. (Also read: Anantha Nageswaran’s take)

(From my post at Yahoo)

In a new notification, the RBI has provided for a complete savings bank rate deregulation, in which banks are allowed to set their own rates for savings bank deposits.

A savings bank (SB) deposit is what is called a checking account abroad, which you can write cheques against, and where money is withdrawable "on demand".

Of the total bank deposits of 56 lakh crores, nearly 14 lakh crores were in savings bank deposits. (2011 March)

SB accounts are an incredibly low cost of funds for banks, who used to pay just 4% as interest. Consider a bank like ICICI which has 29% of its deposits from savings bank accounts, and another 13% from current accounts (paying 0% interest). Even if they paid 10% on the remaining, their overall cost of funds will only be 6.96%.

If a bank lends at a rate of 12% (average) they will make a spread of 5%, a reasonably high number. These spreads are offset by costs — of setting up branches, of printing chequebooks, of validating and clearing cheques, of paying out money on demand. Banks like State Bank of India, Punjab National Bank, HDFC Bank and ICICI Bank have a big branch network, which helps them gather such funds and with a capital cost spread over a large amount, the cost impact on margins is also low. Effectively, these banks have been making reasonable profits on the back of low-cost savings deposits.

But the distribution of savings bank deposits is skewed. SBI owns about 25%, or one-fourth, of the total savings bank deposits in India. The top 10 banks account for 60 to 65% of all deposits in India. Smaller banks like Yes Bank and Indusind Bank, whose deposits are just 2 to 10% of their total borrowings, will want to attract the lower comparative cost of deposits by raising their own savings bank deposit rate. Yes bank has already announced a 2% increase; they now offer 6% on all savings bank accounts.

It is broadly estimated that all banks will have to follow suit, and the cost of funds could go up as much as 1% for savings accounts. This involves a payout of Rs. 14,000 crores as interest, and that will dent profits substantially; by upto 20%.

I doubt the large banks are in any hurry to raise savings bank rates. If anything, they'll look at ways to cut it down now, largely because their customers are a bunch of lazy, financially illiterate people who won't shift away easily.

Consider that:

1)      Even before this announcement, people could easily have placed their money in a fixed deposit account — yields are 9-10% - and move money back when required. To facilitate this process, "sweep-in" FDs were provided, where money was automatically moved to your account if you overshot.

2)     The most efficient way would be to place your money in a liquid mutual fund — which have provided 8% to 8.5% returns. Some liquid funds also provide ATM and debit cards to spend directly from the fund.

Yet, evidently, customers preferred to use savings accounts rather than the above, rational alternatives.

The reasons are many. For one, the average savings deposit in India is very small; with around 100 crore accounts, the average savings account balance is R.s 14,000 — which means an additional 4% a year might save them Rs. 560 — not substantial enough to switch.

Secondly, the cost of switching can be a deterrent. If you have a brokerage account or a mutual fund investment, those are linked to bank accounts that you gave when creating them; changing them involves more paperwork. Certain banks may not have all required features when using their online banking services, which means more trips to the bank. In all, you incur a cost when you switch SB accounts, and for that miniscule benefit it may not make sense.

Thirdly, restrictions on usage may continue. Corporate salary accounts might dictate what you use because they want to transfer salaries using a bank's online' service rather than to use cheques. This means you will need to have an account at the bank which your company deals with, and then transfer money to wherever your operational account is. The additional hassle may not be worth it. If you have paid rent through post dated cheques or are paying an EMI through a bank's electronic clearing service, you will find yourself unable to change accounts easily.

Finally, people aren't rational. None of the factors above are so cumbersome that they can't be done. Nowadays all it takes is a phone call and a few clicks of the mouse. Yet, even if you demonstrated to people how they could have made X rupees more by going with an FD/Liquid fund approach, they could nod their heads and still leave the money in the savings account. Someone I know has more than 10 lakhs in an SB account which they don't even use; but they are too lazy to go move it to Fixed Deposits.

So banks might not need to increase rates on the upside. On the other hand, if rates come down, you can be sure that SB rates will go down like everything else.

Let's assume that to maintain competitiveness, banks do increase rates on savings accounts. They will then try to nickel-and-dime you on charges that you normally wouldn't pay for. Internet banking remains free today, as do ATM usage or cheque-books. But slowly, over the past few years, charges on account usage have appeared — want an extra cheque-book? We'll charge you. Want a bank statement going back one year? We'll charge you. Want a debit card? We'll charge you. Charges now exist if you visit a bank or deposit cash or for cheque returns. Banks earlier had threatened that service fees for banking would go up if savings rates were deregulated — it appears now that service fees have been going up surreptitiously anyway.

RBI is looking to issue new banking licenses, which should take the number of scheduled commercial banks up from the current 80. We should have hundreds of banks, and eventually have enough competition that any petty fee charging would instantly cause us to move.

Also, the importance of a particular bank's savings account is starting to come down. Service levels in all banks are rapidly converging. Usage is going electronic and faceless. Already, I issue just two cheques a month — a rent cheque and one to the local society for maintenance. For everything else — phone bills, petrol, supermarket, broadband, even coffee - I use a credit card, and I make an online transfer to pay the card bill. I can quite easily manage this through any bank account today; I don't really care about their relationship managers who only try to sell me insurance. If I opened a new account that gives me 2% more, I can retain my old account and operate from the new one in less than a day, moving money between each other whenever needed; and I'll feel little pain.

While I don't think this measure itself will cause people to move accounts, it could be individual bank behaviour that prompts an exodus. As the larger banks attach fees to what we have always got for free, we will decide to move, and due to the competitive nature, new banks will make it easy for us. However, this dynamic will take some time to play out, as banks battle out interest rates against ridiculous fees. Eventually, the larger banks will have to give up a little profitability from the deregulation, but they'll profit when rates crash as well. The system is better with unregulated rates than otherwise.

RBI has raised interest rates by 0.25%, taking the repo rate to 8.5% and the reverse repo to 7.5%. The repo rate is what banks pay to borrow overnight from the RBI (against the collateral of government securities) and the reverse repo rate is what banks receive from the RBI for depositing money.

This is the 13th time rates have been raised since March 2010 (when it was at 4.75%).

The Cash Reserve Ratio, or CRR, which is the percentage of deposits banks need to keep as reserve with the RBI, stays at 6%.

RBI indicates that there may not be further hikes this year:

The projected inflation trajectory indicates that the inflation rate will begin falling in December 2011 (January 2012 release) and then continue down a steady path to 7 per cent by March 2012. It is expected to moderate further in the first half of 2012-13. This reflects a combination of commodity price movements and the cumulative impact of monetary tightening. Further, moderating inflation rates are likely to impact expectations favourably. These expected outcomes provide some room for monetary policy to address growth risks in the short run. With this in mind, notwithstanding current rates of inflation persisting till November (December release), the likelihood of a rate action in the December mid-quarter review is relatively low. Beyond that, if the inflation trajectory conforms to projections, further rate hikes may not be warranted. However, as always, actions will depend on evolving macroeconomic conditions.

They expect GDP growth to go down to  7.6% for 2011-12. This is a result of both monetary action and global developments.

In terms of money supply, they expect M3 to grow by 15.5% (it’s currently at 16.5%)

Bank Savings Rate Deregulated

Savings Bank accounts have been giving a rate of 4% (recently upgraded from 3.5%). This was a fixed rate, and many banks used that low rate to good effect, offering customers substantial benefits if they kept money in an SB account.

Now, the RBI has changed this policy and allowed banks to set their own rates for SB accounts. With two restrictions:

a) All amounts below Rs. 1 lakh should get a uniform interest rate (per bank).

b) For above Rs. 1 lakh, banks can have a different interest rate based on amount, but banks can’t differentiated based on customer (like “premier” or “senior citizen” or whatever).

While this is prima-facie negative for banks, do not underestimate their ability to act like a cabal and collectively keep interest rates low. To avoid such a deal, I will note how banks change their SB rates and accordingly, move my transactional money to different accounts (currently HDFC bank).

Home Loan Pre-payment penalty removed (Most likely)

The RBI statement is:

Customer service has always been on top of the Reserve Bank’s policy agenda.  Recognising the need for revisiting the issues of customer service in banks, the Reserve Bank constituted the Damodaran Committee to make recommendations for improving customer service. The Committee has made several recommendations to improve customer service.  We have decided to implement the recommendations of the Committee, on which a broad consensus has emerged, as also the action points which were identified by the Indian Banks’ Association (IBA) and Banking Codes and Standards Board of India (BCSBI) in the last Banking Ombudsmen conference.

That committee has recommended removal of pre-payment penalty for floating rate loans completely, and also for fixed rate loans where you don’t refinance the loan from another bank.

This is negative for banks. Great for everyone else, obviously.

Other Changes

Banks can also open branches without permission in Tier 2 areas (population from 50,000 to 1 lakh) – this was earlier limited to Tiers 3 to 6 only.

They will let Credit Default Swaps (single name corporates happen after end-November 2011. These should have started yesterday and were postponed.

RBI will also allow short selling of Govt securities with a clearer policy by end-December. Plus, market traded 2 and 5 year interest rate futures will be allowed, and they will look to expand liquidity in the G-Sec markets (please involve retail!).

Impact

Obviously banks are hurt, and the bank index is down 2.5%. HDFC Bank is down over 5.5%, while ICICI is only down 1%. Yes Bank, on the other hand, is up 3%.

Bond yields at the 10 year G-Sec were down to 8.68% from the 8.84% seen yesterday, perhaps more of a relief rally after the fear of a 50 bps hike.

Given that it is expiry day, and volumes recently have been low, and this is Diwali week involving holidays the next two days, I would not give too much importance to movements today. What is important now is to hear how banks change their lending and deposit rates, and to brace for the lower growth rate that RBI is talking about. I believe we will slow down substantially more by 2013, with inflation remaining high after March (when the base effect is gone).