In the wake of recent challenges due to the global pandemic, the Reserve Bank of India (RBI) has announced extended relief measures for banks. These include extending the relaxation timeframes related to the Marginal Standing Facility (MSF) scheme until 30th September 2020 and the maintenance of Cash Reserve Ratio (CRR) till 25th September 2020.
Marginal Standing Facility
The RBI instigated temporary measures to manage the financial stress arising from the pandemic. It led to an increase in the borrowing limit of scheduled banks under the MSF scheme from 2% to 3% of their respective deposits starting from 27th March 2020. Initially, this measure was only until 30th June 2020.
The MSF serves a critical function as it allows scheduled banks to borrow overnight from the RBI during emergencies, particularly when interbank liquidity disappears entirely. Interbank lending is when banks lend to each other for a specified term.
Banks can secure these loans by pledging government securities at a rate higher than the repo rate under the Liquidity Adjustment Facility (LAF). The repo rate signifies the rate at which the RBI lends money to commercial banks against securities in case of a fund shortage.
Understanding Repo Rate and MSF
There are distinct differences between the repo rate and the MSF. The former is the rate at which the RBI lends money to commercial banks, often utilised for meeting short-term financial needs. Conversely, the MSF caters to lending overnight to banks.
Borrowing through the repo rate requires a repurchase agreement of securities, while the MSF does not necessitate this. Furthermore, under the MSF, banks can use the securities that come under Statutory Liquidity Ratio (SLR) while availing loans from the RBI.
Statutory Liquidity Ratio
Going by the SLR regulations, commercial banks are mandated by the RBI to sustain a certain proportion of their deposits in the form of liquid assets like cash, gold and unencumbered securities.
Cash Reserve Ratio
The CRR is another critical factor. On 27th March 2020, the minimum daily maintenance of the CRR was decreased from 90% of the prescribed CRR to 80%, initially only until 26th June 2020. The CRR represents the sum of liquid cash that banks must maintain with the RBI, in relation to their total deposits.
Defining Key Terms
‘Scheduled Banks’ refers to any bank included in the 2nd schedule of the RBI Act, 1934. To be categorised as such, a bank should meet two conditions: Its paid up capital and collected fund should not be less than Rs. 5 lakh; its activities should not negatively affect the depositors’ interests.
Whereas ‘Commercial Banks’ include both scheduled and non-scheduled commercial banks which are governed under the Banking Regulation Act, 1949.
The Liquidity Adjustment Facility (LAF) is a tool used by the RBI in monetary policy, allowing banks to borrow money through repurchase agreements (repos) or lend to the RBI through reverse repo agreements.
The ‘reverse repo rate’ the rate at which the RBI borrows money from commercial banks within India.
