-Kanakprabha Jethani | Executive
Vinod Kothari Consultants P. Ltd
In response to the liquidity crisis caused by the covid-19 pandemic, the Reserve Bank of India (RBI) through a Press Release Dated April 03, 2020 announced its third Targeted Long Term Repo Operation (TLTRO). This issue is a part of a plan of the RBI to inject funds of Rs. 1 lakh crores in the Indian economy. Under the said plan, two tranches of LTROs of Rs. 25 thousand crores each have already been undertaken in the months of February and March respectively. This move is expected to restore liquidity in the financial market, that too at relatively cheaper rates.
The following write-up intends to provide an understanding of what TLTRO is, how it is supposed to enhance liquidity and provide relief, who can derive benefits out of it and what will be its impact. This article further views TLTROs from NBFCs’ glasses to see if they, being financial institutions, which more outreach than banks, avail benefit from this operation.
LTRO is basically a tool to provide funds to banks. The funds can be obtained for a tenure ranging from 1 year to 3 years, at an interest rate equal to one day repo. Government securities with matching or higher tenure, would serve as a collateral. Usually, the interest rate of one day repo is lower than that of other short term loans. Thus, banks can avail cheaper finance from the RBI.
Banks will have to invest the amount borrowed under TLTROs in fresh acquisition of securities from primary or secondary market (Specified Securities) and the same shall not be used with respect to existing investments of the bank.
In the current LTRO, the RBI has directed that atleast 50% of the funds availed by the bank have to be invested in investment grade corporate bonds, commercial papers and debentures in the secondary market and not more than 50% in the primary market.
Why were the existing measures not enough?
Ever since the IL&FS crisis broke the liquidity supply chain in the economy, the RBI has been consistently putting efforts to bring back the liquidity in the financial system. For almost a year, the RBI kept cutting the repo rate, hoping the cut in repo rates increases banks’ lending power and at the same time reduces the interest rate charged by them from the customers. Despite huge cuts in repo rates, the desired results were not visible because the cut in repo rates enhanced banks’ coincide power by a nominal amount only.
Another reason for failure of repo rate cuts, as a strategy to reduce lending rates, was that repo rate is one of the factors determining the lending rate. However, it is not all. Reduction in repo rates did affect the lending rate, but the effect was overpowered by other factors (such as increased cost of funds from third party sources) and thus, the banks’ lending rates did not reduce actually.
Further, various facilities have been introduced by the RBI to enhance liquidity in the system through Liquidity Adjustment Facility (LAF) which includes repo agreements, reverse repo agreements, Marginal Standing Facility (MSF), term repos etc.
- Under LAF, banks can either avail funds (through a repurchase agreement, overnight or term repos) or extend loans to the RBI (through reverse repo agreements). Other than providing funds in the time of need, it also allows the banks to safe-keep excess funds with the RBI for short term and earn interest on the same.
- Under MSF (which is a new window under LAF), banks are allowed to draw overnight funds from the RBI against collateral in the form of government securities. The rate is usually 100 bps above the repo rate. The amount of borrowing is limited to 1% of Net demand and Term Liabilities (NDTL).
- In case of term repos, funds can be availed for 1 to 13 days, at a variable rate, which is usually higher than the repo rate. Further, the funds that can be withdrawn under such facility shall be limited to 0.75% of NDTL of the bank.
Although these measures do introduce liquidity to the financial system, they do not provide banks with ‘durable liquidity’ to provide a seamless asset-liability match, based on maturity. On the other hand, having funds in hand for a year to 3 years definitely is a measure to make the maturity based assets and liabilities agree. Thus, giving banks the confidence to lend further to the market.
Bits and pieces to be taken care of
The TLTRO transactions shall be undertaken in line with the operating guidelines issued by the RBI through a circular on Long Term Repo Operations (LTROs). A few points to be taken care of are as follows:
- The RBI conducts auctions (through e-Kuber platform) for extending such facility. Banks have to bid for obtaining funds from such facility. The minimum bid is to be of Rs. 1 crore and the allotment shall be in multiples of Rs. 1 crore.
- The investment in Specified Securities is to be mandatorily made within 30 days of availment of funds. In case the bank fails to deploy funds availed under TLTRO within 30 days, an incremental interest of repo rate plus 200 basis points shall be chargeable, in addition to normal interest, for the period the funds remain un-deployed.
- The banks will have to maintain the amount of specified securities in its Hold-to-Maturity (HTM) portfolio till the maturity of TLTRO i.e. such securities cannot be sold by banks until the term of TLTRO expires. Further, in case bank intends to hold the Specified Securities after the term of TLTRO expires, the same shall be allowed to be held in banks’ HTM portfolio.
The TLTRO operation of the RBI is expected to bring about a relief to the financial sector. The LTRO auctions conducted recently received bids amounting to several times the auction amount. Thus, a clear case of extreme demand for funds by banks can be seen. Although, the recent auctions are yet to reap their fruits, the major benefits that may arise from this operation are as follows:
- The liquidity in the banking system will get increased. Resultantly, the banks’ lending power would increase. Thus, injecting liquidity into the entire economy.
- Since, the marginal cost of funds of the banks will be based on one-day repo transactions’ rate, the same shall be lower as compared to other funding options of similar maturity. A reduced cost of funds for the banks will compel banks to lend at lower rates. Thus, making the short-term lending cheaper.
The picture from NBFCs’ glasses
Barely out of the IL&FS storm, the shadow bankers had not even adjusted their sails and were hit by another crisis caused by the covid-19 disruption. While the RBI is introducing measures for these lenders to cope with the crisis such as moratorium on repayment instalments, stay on asset reclassification based on the moratorium provided etc. The liquidity concerns of NBFCs remain untouched by these measures.
Word has it, the TLTRO is expected to restore liquidity in the financial system. Only banks can bid under LTRO auctions and avail funds from the RBI. This being said, let us look at how an NBFC would fetch liquidity from this.
Banks would use the funds availed under TLTRO transactions to invest in Specified Securities of various entities. Let us assume a bank avails funds of Rs. 1 crore under LTRO. Out of the funds availed, the bank decides to invest 50% in Specified Securities of companies in non-financial sector and 50% in entities in financial sector. Assuming that the entire 50% portion is invested in Specified Securities of 20 NBFCs equally. Each NBFC gets 2.5% of the funding availed by the Bank.
In the primary market
For the purchase of Specified Securities through primary market, the question of prime importance is whether it is feasible for an NBFC to come up with a fresh issue in the current scenario of lockdown. It is not feasible for an NBFC to plan an issue, obtain a credit rating, and get done with all other formalities within a period of 30 days. Thus, the option of fresh issue would generally be ruled out. Primary issues in pipeline may get banks as their investors. However, existence of such issues in pipeline are very low at present.
If an NBFC decides to go for private placement and gets it done within a span of say around a week, it can succeed in getting fresh liquidity for its operations. However, looking at the bigger picture, the restriction of investing only in investment grade securities bars the banks from investing in NBFCs which have lower rating i.e. usually the smaller NBFCs (more in number though). So the benefit of the scheme gets limited to a small number of NBFCs only. Thus, the motive of making liquidity reach the masses gets squashed.
In the secondary market
Above was just a hypothetical example to demonstrate that only a fraction of funds given out under LTRO would actually be used to bring back liquidity to the stagnant NBFC sector. It is important to note here that the liquidity is being brought back through purchase of securities from the secondary market, which does not result in introduction of any additional money to the NBFCs for their operations.
The liquidity enhancement in secondary market would also be limited to Specified Securities of investment grade. Thus, as already discussed, only the bigger size NBFCs would get the benefit of liquidity restoration.
The TLTRO is a measure introduced by the RBI to enhance liquidity in the system. Although it provides banks with liquidity, the restrictions on the use of availed funds bar the banks to further pass on the liquidity benefit. As for NBFCs, the benefit is limited to making the securities of the NBFCs liquid and the introduction of fresh liquidity to the NBFC is likely to be minimal.
Further, the benefit is also likely to be limited to bigger NBFCs, destroying the motive of making liquidity reach to the masses. A few enhancements to the existing LTRO scheme, such as directing the banks to ensure that the investment is not concentrated in a few destinations or prescribing concentration norms might result in expanding liquidity reach to some extent and would create a chain of supply of funds that would reach the masses through the outreach of such financial institutions.
The RBI Governor in his statement on April 17, 2020, addressed the problem of narrow outreach of liquidity injected through TLTRO and announced that the upcoming TLTRO (TLTRO 2.0) would come with a specification that the proceeds are to be invested in investment grade bonds, commercial paper, and non-convertible debentures of NBFCs only, with at least 50 per cent of the total amount availed going to small and mid-sized NBFCs and MFIs. This is likely to ensure that a major portion of the investments go to the small and mid-sized NBFCs, thus expanding the liquidity outreach.
 Our detailed FAQs on moratorium on loans due to Covid-19 disruption may be referred here: http://vinodkothari.com/2020/03/moratorium-on-loans-due-to-covid-19-disruption/
Our write-up on stay on asset classification due to covid-19 may be referred here: http://vinodkothari.com/2020/04/the-great-lockdown-standstill-on-asset-classification/
Our other write-ups on NBFCs may be referred here: http://vinodkothari.com/nbfcs/