SLR cut: A central banker shouldn’t jump into bed with his finance minister

 ARTS RAJANVivek Kaul  

Since yesterday there has been a lot of analysis about the Raghuram Rajan led Reserve Bank of India (RBI) cutting the statutory liquidity ratio(SLR) from 23% to 22.5%. Earlier the banks had to maintain 23% of their deposits in government securities. Now they need to maintain only 22.5%, a cut of 50 basis points. One basis point amounts to one hundredth of a percentage.
This cut, the analysts have concluded will lead to bank giving out more loans. The Business Standard estimates that “the cut will free up about Rs 35,000 crore with banks which they can now lend.”
The newspaper does not explain how they arrived at that number. But an educated guess can be made. Currently, the aggregate deposits of scheduled commercial banks in India amounts to Rs 7,855,520 crore. The SLR ratio has been cut by 50 basis points or 0.5%. This amounts to around Rs 39,278 crore (0.5% of Rs Rs 7,855,520 crore) of the total deposits of banks. From this number, the ballpark number of Rs 35,000 crore seems to have been derived.
It is important to make things simple, but not simplistic. The assumption being made here is that now that banks need to invest a lesser amount in government securities, they will do so and prefer to lend more money instead.
But is that really the case? The latest numbers released by the RBI show that scheduled commercial banks had invested nearly 29.27% of their deposits in government securities. This when the SLR had stood at 23%. What does this tell us? It tells us that banks prefer to invest in government securities than lend money.
This is not a recent phenomenon. In late September 2007, when the economic scenario was significantly better than it is now, scheduled commercial banks had nearly 31% of their deposits invested in government securities. In mid May 2012, the number had stood at 30%.
Given this, even though banks are required to maintain only a certain portion of their money in government securities, they have maintained a significantly higher amount over the years. Whether this is lazy banking or the lack of good investment opportunities that only the banks can tell us.
In fact, it is interesting to see how things panned out after the RBI cut the SLR from 24% to 23% on July 31, 2012. As on July 28, 2012, the banks had invested nearly 30.6% of their deposits in government securities. Three days later, the RBI cut the SLR. A little over six months later in early February 2013, the government securities to deposit ratio stood at 30.4%. So, the banks did cut down on their exposure to government securities, but not significantly. In fact, as on July 26, 2013, nearly a year later, the government securities to deposits ratio stood at 30.8%. This was higher than the ratio before the SLR cut.
What this clearly tells us is that a cut in SLR does not necessarily mean that banks will invest less in government securities and lend that money instead.
The RBI of course understands this. If it really wanted to ensure that banks had more money to lend it would have cut the cash reserve ratio (CRR). CRR is the portion of their deposits that banks need to hold with the RBI. It currently stands at 4%.
The RBI does not pay any interest on the money that banks maintain with it to fulfil their CRR obligations. Hence, when the RBI cuts the CRR, banks have an incentive to lend the money that is freed up. The same scenario does not hold in case of an SLR cut because banks get paid interest on the money they invest in government securities.
So that brings us to the question, why did Rajan cut the SLR? My guess on this is that there was pressure on him from the Finance Ministry to show that RBI was serious about “economic growth” and do something that forced banks to lend more. And that something came in the form of an SLR cut. It was his way of telling the government, look you wanted me to do something, I did something. If banks are still not lending, what can I do about it?
In the monetary policy statement Rajan said that there were still “Upside risks” to inflation “in the form of a sub-normal/delayed monsoon on account of possible El Nino effects, geo-political tensions and their impact on fuel prices, and uncertainties surrounding the setting of administered prices.” What this tells us clearly is that Rajan is still not totally convinced that we have seen the last of the high inflation that has prevailed over the years.
What this further tells us is that Rajan continues to be his own man as he was in the past and is unlikely to be weighed in by pressure from the finance ministry. It is important to remember here what economist Stephen D. King writes in
When the Money Runs Out “A central banker who jumps into bed with a finance minister too often ends up with a nasty dose of hyperinflation.”
Given this, it is important that Rajan stays as independent as he has been since taking over as the RBI governor in September 2013.

The article originally appeared on www.firstbiz.com on June 4, 2014

 (Vivek Kaul is a writer. He can be reached at vivek.kaul@gmail.com)  

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About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

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