Banks told to set aside 5% of funds under CBLO

MUMBAI: The Reserve Bank of India (RBI) on Tuesday moved to stop banks from gaming the system saying that lenders have to set aside 5% of the funds borrowed under the so-called collateralized borrowing and lending obligation (CBLO), also with the central bank under the cash reserve ratio (CRR).

"The objective of developing CBLO, as a money market instrument, has been broadly achieved", so the funds that banks borrow from it will attract the 5% CRR stipulated for bank deposits from November 21, the central bank said in its policy document on Tuesday.

CBLO is an alternative to the inter-bank market where financial companies such as banks, mutual funds and finance companies lend and borrow money against government securities. Ever since RBI got into easy monetary policy last year to avert a credit crisis, after the collapse of Lehman Brothers, rates in the CBLO market fell to as low as 1%, which is lower than the 3.25%, which RBI pays banks for funds parked with it.

So, some banks borrowed money from the CBLO market at lesser than 3.25% and gave to the central bank, pocketing the difference. The rates in the CBLO market varied between 1% and 3% in the past few months.

"People were borrowing in the CBLO market and lending it in other overnight markets like call money and RBI liquidity window", said Pradeep Madhav, managing director, STCI Primary Dealership, a bond house. "RBI wants to cut down this arbitrage by introducing CRR requirements."

CRR will now be calculated, as a fraction of the sum of a bank���s Net Demand and Time Liabilities (NDTL) and CBLO borrowings. RBI does not pay any interest to the banks for funds under CRR.

"Volumes in the CBLO segment have increased over the years, especially after the phasing out of the non-banks from the inter-bank market", said the policy note. The daily volume in the CBLO market is Rs 60,000 crore a day from Rs 6 crore in 2003, it said.

The regulator also restored the proportion of deposits that banks should invest in government bonds to 25% from 24%, as the liquidity position eased. During the credit crisis the central bank cut the ratio to 24%. Many see the move as RBI "urgency" in sucking out excess liquidity from the banking system, which could also increase a bank���s cost of funds.