In the bi-monthly policy statement, RBI holds rates steady, while moving the SLR down by 0.5% to 22%.

No Rate Changes

Repo, or the rate at which banks borrow from the RBI overnight, is at 8%. This is now getting less and less relevant as banks borrow a tiny amount overnight. The rest is borrowed at 7-day and 14-day term repos, where the rates are “bid” for. See the liquidity provided yesterday:

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The 7 day and 14 day repos have more than 80,000 cr. borrowed, while overnight repo (the 1 day number) is only 10,000 cr. The overnight repo limit is 0.25% of NDTL which is around Rs. 20,000 cr. which was only half-filled. (In fact, in today’s auction only Rs. 1400 cr. was borrowed overnight)

Repo rates are thus insignificant.

SLR Cut to 22%

The SLR is the Statutory Liquidity Ratio. It’s what banks are required to hold as “liquid” instruments. This doesn’t actually mean liquidity; it means buy government bonds. In a nutshell, the “SLR” requirement is a limit that ensures there is bank demand for government bonds. Now, 22% of your deposits have to be used to buy G-Secs, (and 4% is CRR), only the rest can be lent out.

For a deeper understanding, please check our article on Cash Reserve and Liquidity Ratios.

The lowering of SLR might have little or no impact. As of July 11 (our last data point) total bank investments in G-Secs were 27% of their total deposits (NDTL).

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The SLR cut means banks can reduce this amount to 22%. Of course, they don’t usually do that – they need about 1% for the repo needs, and probably another 2% for MSF, which means the real lower bound is around 25%.

But as we can see, the current investment is comfortably above that, despite cuts in SLR.

Which means the overall goal of cutting SLR might help banks a little by reducing their need to hold G-Secs, and help the rest of us who need more credit.

HTM limit cut to 24%

The only other relevant thing in this policy was that the Hold-To-Maturity limit (HTM) was cut to 24% of NDTL. This is the resumption of the earlier measure of bringing this concept

Banks can hold bonds that trade in the market. But if the bond prices fall (when yields rise) the bank has to take the loss on to their books.

A “Hold To Maturity” security (or HTM) is like saying, look I don’t care about the price of this bond in the market, I will hold it until the security matures. So, they don’t take the Mark-To-Market hit (gain or loss) on such securities.

Why is this important? Banks have to hold SLR by regulation. If they had to buy those bonds and hold them, but also take losses when those prices fell, that would be too much. So, technically, banks should be allowed to mark at least the SLR limit of securities as HTM.

When bond prices fell in Sep 2008, banks requested freedom to move their loss making securities to the HTM category. They were allowed to, as a one time measure. Plus, they could exceed the HTM limit (25% of all securities) if they held only G-Secs as HTM beyond the limit.

This was allowed for banks which had less than 24.5% of their NDTL in HTM securities. The difference is that the first limit is a percentage of total investments, whereas the second is a percentage of total deposits.

The 24.5% is brought down to 24%. This is not bad – it should eventually fall to 22%! (The new SLR)

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Our View

This is a business-as-usual policy. We expected no rate changes, and a small tweak in SLR etc. This has happened.

Impact on yields: the 10 year has totally lost it and run out to 8.57% while the old 10 year trades at 8.80%. They were at 8.49% and 8.71% respectively. So the bond markets don’t like it, which is fair – the changes in SLR and HTM means banks will want to sell government bonds, and thus, the bond market is adjusting to the perceived increase in supply.

The rate cut isn’t expected but the signal, according to us, is in the date of the next policy: September 30, 2014.

Policy dates comes on the first Tuesday of a period, and having it on Sep 30 is strange. But consider this – it’s the end of the quarter. That means, if a rate cut is announced on that day, it will bring down yields immediately, and the lower yield (and thus higher price) will impact banks positively. Why? Because they take the yield on the last day of the quarter to mark their books for the quarter.

So, it’s now a signal – if data is good, a rate cut will happen on September 30. In fact, it seems to us that unless data is really bad, the rate cut will happen. Risks of a bad monsoon and price jumps remain. As do risks of some mad chap going even more mad in Russia/Ukraine or Israel/Gaza.

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