Some smart banks may be pulling the wool over RBI's eyes by using funds for the purpose not intended for.
They are borrowing from the central bank at 6.5% in the liquidity adjustment facility (LAF) and investing in mutual funds and certificate of deposits that yield at least 1.5 percentage points to 3.5 percentage points more.
The central bank's generous liquidity facility programme and some relaxation on the mandatory holding of government bonds limits to boost lending, has provided a neat arbitrage opportunity for those banks that have surplus bonds, to profit from tight liquidity.
"There is an arbitrage opportunity - wherein banks are borrowing from RBI and investing in CD or parking money in mutual funds," said TS Srinivasan, deputy general general- Treasury of Indian Overseas Bank.
"This, however, has reduced marginally off late as credit demand has improved."
The arbitrage is evident form the data that shows that mid January, banks had invested close 70,000 crore in mutual funds even as the borrowing from the Reserve Bank of
The spread between the one-year bank certificate of deposit yield and RBI's repo rate, the rate at which it lends to banks, stood at 3.5% on Thursday, near its highest 3.6%. It has averaged 2.04% over the last one year, up from 1.56% over the last two years and 1.68% in four years, according to Bloomberg data.
Treasury heads of a few banks said such arbitrage was prevalent, but did not want to be identified.
"The LAF auction is available on tap so banks who enjoy a good SLR ratio have been taking advantage of the current scenario and are getting attractive returns by deploying the money at higher rates," said Ramesh Kumar, senior V-P- Debt, Asit C Mehta Investments.
Banks holding excess government securities than the stipulated 24% by RBI are pledging those securities and borrow at 6.25%. Those funds are invested in mutual funds, or invested in rival banks' certificate of deposits, where rates touched 10%.
Short-term rates are soaring as demand for loans are rising due to the 8.9% economic growth. Bank loans are growing at more than 24% while deposits are climbing about 16%, forcing banks to borrow in the short-term market.
The credit to deposit ratio, the amount of funds loaned in relation to the deposits, touched 102% recently, triggering some stern warnings from the central bank governor D Subbarao.
"We told them both that they must increase their deposits and they must restrain their credit and that credit growth and deposit growth have to be aligned, Subbarao said on January25 while announcing quarterly monetary policy. "Additionally, I think the banks told you in their press conference, we also said, and I have just mentioned in my statement that in the guidance, we will monitor this very closely and use our supervisory responsibilities to ensure that those banks which are far out of line are brought in line."
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