Banks and Liquidity Crisis. It is their own mess

Apropos the edit “RBI waits for FM” (March 12), the central bank’ move to cut the cash reserve ratio by 0.75 percentage point a week ahead of its policy review was quite unexpected. This indicates that the Reserve Bank of India (RBI) recognises the liquidity tightness in the market because of large borrowings by banks. The present liquidity crunch is partly owing to banks’ inefficient management of assets and liabilities. The slowdown has affected banks’ credit portfolio since there is no credit expansion or repayment of loans. With high non-performing assets (NPAs), it is only natural to be more impacted by the liquidity crunch because of lack of recycling of funds. More NPAs mean less profit since there is no repayment of interest. Given the high inflation rate, banks raised interest rates on short-term deposits and deployed resources in long-term government securities and long-term advances. There is a mismatch between banks’ short-term liabilities and short-term assets. Adjustment of interest rates will enhance demand for credit and banks will see more liquidity tightness. The escape route is to drastically bring down NPAs but that, again, is dependent on several other factors. Things can improve only after the government announces the Budget.

T V Gopalakrishnan Mumbai

(This appeared in Business-Standard dt14/03/12)