Rising interest rate
- October 27, 2022
- Posted by: OptimizeIAS Team
- Category: DPN Topics
Rising interest rate
Experts opine that banks are in a Catch-22 situation
- Catch-22 situation-a problematic situation for which the only solution is denied by a circumstance inherent in the problem.
- In the present context it denotes a situation where banks want to reduce their surplus SLR securities to support credit growth but rising yields are not offering them the opportunity.
- Deposits are not growing at the same rate as credit i.ecredit growth>deposit growth.
- Banks are also holding excess SLR securities on the backdrop of earlier low credit growth.
- If all banks want to sell excess SLR (getting liquidity) to support credit growth given the number of buyers will lead to an excess supply of bonds>demand. Thus, prices of bonds would reduce and yield rise (as price and yield are inversely related). Bank treasuries losing by selling excess securities
- Impact– rise in deposit rates to encourage deposits instead of selling excess SLR securities.
Statutory Liquidity Ratio
- SLR is the minimum percentage of deposits that the commercial bank maintains through gold, cash and other securities.
- These deposits are maintained by the banks themselves and not with the RBI or Reserve Bank of India unlike the Cash Reserve Ratio.
- Banks earn returns on money parked as SLR
- Section 24 and Section 56 of the Banking Regulation Act 1949 mandates all scheduled commercial banks, local area banks, Primary (Urban) co-operative banks (UCBs), state co-operative banks and central co-operative banks in India to maintain the SLR.
- It comprises of– cash, gold and SLR securities, comprising:
- Dated securities
- Treasury Bills of the Government of India;
- Dated securities of the Government of India issued from time to time under the market borrowing programme and the Market Stabilization Scheme;
- State Development Loans (SDLs) of the State Governments issued from time to time under the market borrowing programme; and
- Any other instrument as may be notified by the Reserve Bank of India
How excess SLR holdings?
- Banks are required to invest 18 percent of the deposits they mobilise in SLR securities.
- During times when credit growth is low, they invest over and above the regulatory minimum, leading to excess SLR holdings.
- Excess SLR holdings provide collateral buffers to banks for availing funds under the liquidity adjustment facility(LAF) and are also a component of the liquidity coverage ratio (LCR).
How are SLR and yield related?
- If all banks want to sell excess SLR (getting liquidity) to support credit growth, the number of buyers will lead to an excess supply of (g-sec)bonds>demand. Thus, prices of bonds would reduce and yield rise (as price and yield are inversely related).
- Bank treasuries losing by selling excess securities.
Bonds and bond yield:
- A bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental).
- A company/govt. issues bonds to raise money and they pay regular fixed interest to the bondholder. This interest rate is called the coupon rate. It is declared on the face value of the bond and remains fixed until maturity.
- However, since bonds are tradeable, they also give returns. These returns are called bond yields.
- The bond prices and yields generally move in opposite directions.This is because, as a bond’s price increases, its yield to maturity falls.
- Example- for a bond purchased with a par (face) value of $100, and a 10% annual coupon rate, its yield would be 10% (10/100 = 0.10)
- If the bond price falls to $90, the yield would become 11% (10/90 = 0.11).