by Deepthi Sai
The marginal standing facility (MSF) was introduced by the Reserve Bank of India (RBI) and has been effective since 9 May, 2011. Before we see what this facility entails, it is important to review a few terms. Also, it is highly recommended that you read the article ‘Banks, the State and Stuff’ first for better understanding.
After accounting for CRR and SLR, the remaining funds are used to make loans to people.
The RBI uses CRR and SLR to control the amount of money in circulation. Why does it need to control this? If there is an inflation in the economy, the RBI increases CRR and SLR rates. The banks now have to keep aside a larger amount of their funds, decreasing the amount they can loan out to people. Now that people have less money to spend, their demand for goods fall. Sellers start pulling down the prices of the goods to be able to sell to the less willing customers. Thus, through the use of CRR and SLR, we can see how the RBI could battle the problem of inflation.
Very often, banks buy government securities over and above the SLR requirement. The amount of securities bought over the required SLR are called ‘excess securities.’ Banks do this primarily to be able to acquire liquid cash whenever they want. They keep the excess securities as collateral against default and borrow money from the RBI. The rate at which banks can borrow from the RBI currently stands at 8 percent per annum. The bank buys the security from the RBI for some amount. When the bank is in dire need of cash, it sells the security back to the RBI. The bank must, however, buy the security once again from the RBI, except at a price 8 percent higher than earlier. This is called the ‘repurchase operation,’ or ‘repo,’ and the interest rate at which the commercial banks borrow from the RBI is called the ‘repo rate.’ All these transactions happen at auctions conducted on a daily basis by the RBI.
The RBI, too, borrows from commercial banks at times. The rate at which the RBI borrows money from commercial banks is called the ‘reverse repo rate.’ Currently, the reverse repo rate stands at 7 percent. Repo and reverse repo operations together make up a ‘liquidity adjustment facility’ (LAF).
Now what happens when banks need cash urgently but do not have excess securities? This was pretty much the situation in the the first half of 2011. Earlier, to combat the problem, the RBI would increase the frequency of auctions being conducted from one to two repo auctions per day and pull down SLR requirements.
To avoid having to pull down SLR and increase the number of auctions conducted, the RBI finally introduced the ‘marginal standing facility’ (MSF). This facility entails two things:
MSF had remained unused for a long time. In 2012 however, banks resorted to MSF repeatedly. Banks borrowed Rs. 850 crores (approx. $155.5 million) from the RBI's marginal standing facility on July 3 and then again Rs. 50 crores (approx. $9.1 million) on August 22. Banks have been falling short of liquidity because of the fluctuations in the dollar-rupee rates and also because government borrowings have increased in recent times.
Ordinarily, when depositors withdraw their money from a bank in large amounts, banks tend to borrow from the RBI. The banks cannot ask people to whom they have loaned money to repay their loans before maturity, as this could tarnish the bank’s credibility. In such situations, the RBI is considered a ‘lender of last resort.’ Now if the bank does choose to resort to MSF, it means that even the option of using repo has failed them. So if banks are using MSF then we can conclude that they are most definitely stressed for money.
"List/Grid Tag Archives: Net Demand and Time Liabilities." Net Demand And Time Liabilities. The Banking Bible, n.d. Web. 02 Oct. 2012. <http://thebankingbible.com/tag/net-demand-and-time-liabilities>.
"Reserve Bank of India." Reserve Bank of India. Government of India, 21 Sept. 2012. Web. 02 Oct. 2012. <http://www.rbi.org.in/scripts/WSSView.aspx?Id=17633>.
Goyal, Rajesh. "Latest Rates for CRR, SLR, Bank Rate, Cash Reserve Ratio, MSF." Latest Rates for CRR, SLR, Bank Rate, Cash Reserve Ratio, MSF. Allbankingsolutions.com, 2011. Web. 02 Oct. 2012. <http://www.allbankingsolutions.com/DATA.htm>.
"RBI Lets Banks Tap MSF Window to Ease Liquidity." The Economic Times. The Economic Times, 22 Dec. 2011. Web. 02 Oct. 2012. <http://articles.economictimes.indiatimes.com/2011-12-22/news/30546844_1_cblo-repo-window-msf-window>.
"Proactive Steps for Liquidity Promised." Proactive Steps for Liquidity Promised. Business Standard, 18 Apr. 2012. Web. 02 Oct. 2012. <http://www.business-standard.com/india/news/proactive-steps-for-liquidity-promised/471736/>.
Shenoy, Deepak. "The Marginal Standing Facility." Capital Mind. N.p., 24 Dec. 2011. Web. 03 Oct. 2012. <http://capitalmind.in/2011/12/the-marginal-standing-facility/>.
The marginal standing facility (MSF) was introduced by the Reserve Bank of India (RBI) and has been effective since 9 May, 2011. Before we see what this facility entails, it is important to review a few terms. Also, it is highly recommended that you read the article ‘Banks, the State and Stuff’ first for better understanding.
Cash Reserve Ratio
All banks are mandated by the RBI to keep aside a fraction of the deposit made to them as reserve. Currently, the cash reserve ratio (CRR) in India stands at 4.5 percent. So say State Bank of India receives a deposit from any person of Rs. 100, Rs. 4.50 must be kept with the RBI as CRR. (The CRR was explained in more detail in ‘Banks, the State and Stuff.’)Statutory Liquidity Ratio
The RBI requires banks to maintain some amount of gold, cash and government-approved securities (bonds). The statutory liquidity ratio (SLR) currently stands at 23 percent.After accounting for CRR and SLR, the remaining funds are used to make loans to people.
The RBI uses CRR and SLR to control the amount of money in circulation. Why does it need to control this? If there is an inflation in the economy, the RBI increases CRR and SLR rates. The banks now have to keep aside a larger amount of their funds, decreasing the amount they can loan out to people. Now that people have less money to spend, their demand for goods fall. Sellers start pulling down the prices of the goods to be able to sell to the less willing customers. Thus, through the use of CRR and SLR, we can see how the RBI could battle the problem of inflation.
Very often, banks buy government securities over and above the SLR requirement. The amount of securities bought over the required SLR are called ‘excess securities.’ Banks do this primarily to be able to acquire liquid cash whenever they want. They keep the excess securities as collateral against default and borrow money from the RBI. The rate at which banks can borrow from the RBI currently stands at 8 percent per annum. The bank buys the security from the RBI for some amount. When the bank is in dire need of cash, it sells the security back to the RBI. The bank must, however, buy the security once again from the RBI, except at a price 8 percent higher than earlier. This is called the ‘repurchase operation,’ or ‘repo,’ and the interest rate at which the commercial banks borrow from the RBI is called the ‘repo rate.’ All these transactions happen at auctions conducted on a daily basis by the RBI.
The RBI, too, borrows from commercial banks at times. The rate at which the RBI borrows money from commercial banks is called the ‘reverse repo rate.’ Currently, the reverse repo rate stands at 7 percent. Repo and reverse repo operations together make up a ‘liquidity adjustment facility’ (LAF).
Now what happens when banks need cash urgently but do not have excess securities? This was pretty much the situation in the the first half of 2011. Earlier, to combat the problem, the RBI would increase the frequency of auctions being conducted from one to two repo auctions per day and pull down SLR requirements.
To avoid having to pull down SLR and increase the number of auctions conducted, the RBI finally introduced the ‘marginal standing facility’ (MSF). This facility entails two things:
- MSF operates at a rate of 9 percent rather than 8 percent, i.e., a full percentage point higher than the repo rate. Thus borrowing under the MSF is more expensive since banks will be paying higher interests on their borrowings.
- As explained earlier, to borrow from the RBI, banks keep excess securities as collateral. When a bank resorts to MSF, it does not exactly have any excess securities. Though it only has enough securities to meet SLR requirements, it must keep treasury bonds as collateral to borrow from the RBI. This will naturally violate the SLR requirement. However, the RBI (Reserve Bank of India) allows for a relaxation in SLR requirement for banks that borrow under MSF. The relaxation given is a maximum of 1 percent of the bank’s deposit base. Any violation is SLR beyond this is not tolerated.
MSF had remained unused for a long time. In 2012 however, banks resorted to MSF repeatedly. Banks borrowed Rs. 850 crores (approx. $155.5 million) from the RBI's marginal standing facility on July 3 and then again Rs. 50 crores (approx. $9.1 million) on August 22. Banks have been falling short of liquidity because of the fluctuations in the dollar-rupee rates and also because government borrowings have increased in recent times.
Ordinarily, when depositors withdraw their money from a bank in large amounts, banks tend to borrow from the RBI. The banks cannot ask people to whom they have loaned money to repay their loans before maturity, as this could tarnish the bank’s credibility. In such situations, the RBI is considered a ‘lender of last resort.’ Now if the bank does choose to resort to MSF, it means that even the option of using repo has failed them. So if banks are using MSF then we can conclude that they are most definitely stressed for money.
References
"Banks Borrow Rs 8.50 Bn via RBI's MSF on Wednesday." The Economic Times. The Economic Times, 4 July 2012. Web. 02 Oct. 2012. <http://economictimes.indiatimes.com/markets/money-markets/Banks-borrow-Rs-850-bn-via-RBIs-MSF-on-Wednesday/articleshow/14666914.cms>."List/Grid Tag Archives: Net Demand and Time Liabilities." Net Demand And Time Liabilities. The Banking Bible, n.d. Web. 02 Oct. 2012. <http://thebankingbible.com/tag/net-demand-and-time-liabilities>.
"Reserve Bank of India." Reserve Bank of India. Government of India, 21 Sept. 2012. Web. 02 Oct. 2012. <http://www.rbi.org.in/scripts/WSSView.aspx?Id=17633>.
Goyal, Rajesh. "Latest Rates for CRR, SLR, Bank Rate, Cash Reserve Ratio, MSF." Latest Rates for CRR, SLR, Bank Rate, Cash Reserve Ratio, MSF. Allbankingsolutions.com, 2011. Web. 02 Oct. 2012. <http://www.allbankingsolutions.com/DATA.htm>.
"RBI Lets Banks Tap MSF Window to Ease Liquidity." The Economic Times. The Economic Times, 22 Dec. 2011. Web. 02 Oct. 2012. <http://articles.economictimes.indiatimes.com/2011-12-22/news/30546844_1_cblo-repo-window-msf-window>.
"Proactive Steps for Liquidity Promised." Proactive Steps for Liquidity Promised. Business Standard, 18 Apr. 2012. Web. 02 Oct. 2012. <http://www.business-standard.com/india/news/proactive-steps-for-liquidity-promised/471736/>.
Shenoy, Deepak. "The Marginal Standing Facility." Capital Mind. N.p., 24 Dec. 2011. Web. 03 Oct. 2012. <http://capitalmind.in/2011/12/the-marginal-standing-facility/>.
Good job! Very informative.
ReplyDeleteSimple to understand, you guys are awesome!
ReplyDelete