What is the current surplus liquidity in banking system?

Posted in Updates on Mar 23, 2024

A dramatic change followed three months of low liquidity conditions in the banking sector as it went into surplus mode. This surprising development was sparked by the Reserve Bank of India's (RBI) decision to take in more than Rs 40,000 crore from the market while government spending was on the rise. Liquidity Relief: This short-term excess was welcomed by market observers who saw it as a break from the ongoing tight liquidity crisis. Experts warn that this excess might not last long because of several factors that affect the financial system's liquidity.

Factors Influencing the Current Scenario:

1. An Increase in Fund Demand:

Despite the recent surplus, it is expected that year-end targets and impending tax obligations will put strain on liquidity.

2. Disappointing Response to VRRR Auctions:

The market's weak response to the RBI's attempts to control liquidity through Variable Rate Reverse Repo (VRRR) auctions suggests that investors are being cautious.

Tight Liquidity Causes:

1. Minimal Government Expenditure:

Government spending was comparatively low until December 2023, which led to huge bank cash levels and a lack of available funds in the system.

2. Expanding Credit Growth

Borrowing more money resulted in the banking system's liquidity becoming even more constrained.

Changing Scenery:

1. Public Expenditure: The liquidity position has greatly improved as a result of recent large spending by the federal and state governments, providing a brief respite from the tight conditions.

2. Decreased Debt: The central government's borrowing has been completed, releasing about Rs 33–35,000 crore every week, which has eased some of the liquidity pressure.

Gazing Forward:

1. Temporary Oversupply: Although there is currently a surplus, analysts predict that it won't last for long because of upcoming tax outflows including corporation tax and Goods and Services Tax (GST) payments.

2. The volatility of the market: Increased market volatility is anticipated in the upcoming weeks due to year-end activities and financial commitments.

RBI's Position:

1. Active Management: Through a variety of strategies, such as variable rate repo operations and fine-tuning interventions, the RBI continues to play a crucial role in controlling liquidity.

   Conclusion:

   In conclusion, the recent shift towards surplus liquidity in the banking system offers a brief respite from the prolonged period of tight conditions. However, it is essential to remain cautious as various factors continue to influence liquidity dynamics. The proactive measures taken by the RBI play a vital role in navigating these fluctuations and ensuring financial stability within the banking sector.

   FAQs (Frequently Asked Questions):

2. How long is the surplus liquidity expected to last? The surplus liquidity is anticipated to be short-lived due to upcoming tax outflows and year-end financial activities.
3. What measures has the RBI implemented to manage liquidity? The RBI has utilized measures such as variable rate repo operations and fine-tuning interventions to actively manage liquidity within the banking system.
4. What factors contributed to the tight liquidity conditions in the banking system? Factors such as low government spending and rising credit growth contributed to the tightening of liquidity within the banking system.
5. How does surplus liquidity impact market volatility? Surplus liquidity can lead to increased market volatility, particularly during periods of heightened financial activity such as year-end obligations.
6. Are there any long-term solutions proposed to address liquidity challenges within the banking system? Long-term solutions may involve a combination of fiscal policies aimed at boosting government spending and monetary policies aimed at regulating credit growth to maintain a balanced liquidity environment.