The Hindu Business Line : WANING POWER OF THE REPO

When the Reserve Bank of India raised the repo and reverse-repo rates this year, ostensibly to control inflation, banks let it be known that this would raise the cost of funds what with the tighter liquidity in the system, the hike in deposit rates and a squeeze on the margins. After all, any central bank decision to raise the cost of funds would have an effect on the borrowers. The RBI had raised both repo and reverse repo rates with the difference tilted slightly against banks-as-borrowers. This, the general opinion held, would lead to a hike in the overall lending rate for the final consumer. But events have not entirely borne that out. . To be sure banks have raised the interest on certain loans, especially retail and home, but the repo rates have not been the cause. The hikes were commercial decisions to cash in on a booming market, in retail for instance, or because of the higher credit disbursal cost, as in the case of private banks leading some, like ICICI Bank, to up their prime lending rate.

The repo as a device to move bank lending rates is clearly not as potent as it might have been. Auctions at the RBI's repo window, following a tightening of liquidity soon after the policy announcement, saw lacklustre participation by banks. On the other hand, the reverse repo window, through which banks park their excess liquidity, has seen brisk business with the RBI saddled with roughly Rs 14,000 crore. The excess liquidity was the result of the banks unwinding the Market Stabilisation Scheme securities when faced with liquidity shortage. The MSS and the Liquidity Adjustment Facility (LAF) are the central bank's ways of adjusting funds with banks and one striking example of the manner in which they worked to stabilise the system was in late December into January following the redemption of India Millennium Deposit bonds when supply constraints were eased through the repo window.

Events since the IMD redemption have shown up the resilience of the financial system, and highlighted the changing relationship between the RBI and banks. The apex bank has become more responsive to changes in market conditions such as fluctuations in liquidity and is ready with a slew of instruments. But, more significantly, the responses to the auctions at repo windows showcase the extent to which banks have tuned themselves to market conditions and their willingness to stretch themselves in the pursuit of business. Credit growth has been twice as much as that of deposits but banks have so far managed by garnering non-deposit funds as well. An asset-liability mismatch could be looming but that challenge banks must face on their own.

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