TLTRO: Analysing RBI’s Novel Monetary Policy

By the end of 2019, India was battling an economic slowdown. Growth forecasts had already been down-scaled to 5% from 6.1% at the beginning of the year. Coupled with soaring inflation, (at 4.7% based on CPI) the need for a switch from the current accommodative monetary policy soon became evident. This need was further instigated by the sputtering of the RBI’s trusted trickle down effect : lowering rates at which banks borrow from the RBI lowers cost of acquiring funds for banks which eventually cuts commercial rates of interests. This would incentivise investment and spur economic activity. But even after repo cuts of approximately 135 bps, lending rates of banks failed to show a similar trend. Commercial banks, it appeared, had multiple sources of borrowing funds and a simple repo cut did little to lower overall costs. Enter LTRO or Long Term Repo Operations, a European Bank derived monetary policy. Introduced on February 6, 2020,  LTRO was to augment long-term borrowing in contrast to other policies like LAD and MSF. With LTRO, banks were auctioned loans worth Rs. 1,00,000 Cr.  at the prevailing repo rate for a maturity period of one to three years. Repo rates are interest rates for short-term borrowing, whereas interest on long-term loans is much higher. Equipped now, with cheaper cost of funds, banks could effectively pass on low-interest rates to the economic playing field. 

Not a month after the introduction of LTRO, the COVID pandemic posed an even larger threat to the Indian economy. One of the worst-hit was the financial sector. With the global economy coming to a sudden standstill, multiple job losses and business foreclosures, a majority of the borrowers of NBFCs (Non-Banking Finance Companies) were unable to repay their loans. While borrowers were let off with a six month moratorium (extension in repayment due to extraordinary circumstances), NBFCs, that had their own loans from banks, were expected to pay on time. Conveying the extent of an NBFCs’ liabilities, as of this date, Bajaj Financing Ltd. has Rs. 515 cr. maturing (to be paid back) by September 30th. With the major source of external revenue pulled out from underneath, NBFCs could look to only two solutions for close coming repayment : first, through internal cash reserves and the second, through selling their shares in bonds. The options narrow further for NBFCs with meagre cash reserves. They could look only to bonds and CPs for funding. Here is where the problem deepens. With the advent of the pandemic, things weren’t looking too good for the bonds market, either. The biggest player in the market, mutual funds, had started seeing an unusually high no. of redemptions as investors turned risk averse in the current economy. They needed to find funds to accommodate excessive withdrawal and could not afford to buy with jumpy investors at hand. Under these circumstances, mutual funds retreated from the bonds market, participating only as a seller. The worst of the tightening liquidity came after Franklin Templeton mutual funds suspended 6 of their debt schemes, leaving investors in the dark about their money. NBFCs and MFIs(Micro financing industries) were trapped in the swirl. On March 27, the RBI revived its policy, now coined TLTRO or Targeted Long Term Repo Operations. 

Under this policy, banks were similarly auctioned loans in four tranches of 25,000 crore each at the prevailing repo rate, then 5.15%. This time, banks needed to use half of this newly acquired liquidity to invest in bonds within 30 working days of raising the funds. Once those bonds matured, funds would be redeployed until the 1-3 year term ended. No single entity was to be invested in with more than 10% of the funds. NBFCs would be funded with these subscriptions and banks would stabilise the market by replacing MFs as the major source of demand. Bids raised under TLTRO were Rs. 60,500 cr., implying a bid to cover ratio (ratio of the amount bid to the amount notified) of 2.4. This deemed the policy hugely popular. Unfortunately, it soon failed. Despite CRR relaxations, banks were reluctant to subscribe to bonds issued by weaker NBFCs with abysmal credit ratings. There was a looming threat of their default before the bonds’ maturity. Banks instead invested in large corporate entities with minimal risk of non-repayment, leveraging the TLTRO to profit both ways. With corporate giants soaking all generated liquidity, NBFCs continued to starve. This called for new rules. 

RBI made an immediate announcement of TLTRO 2.0 on April 17th. This time tightening norms for the benefit of weaker NBFCs and MFIs. RBI released the policy with an amount of 50,000 crores. At least half of this amount was to be invested with the following guidelines: 

1.) 10 per cent should be apportioned to securities issued by MFIs

2.) 15 per cent should be allocated to securities to NBFCs with an asset size of 500 crores and below. 

3.) 25 per cent to NBFCs with 500 and 5000 crores as asset size. 

The investment decision of the remaining 50 per cent was left at the discretion of banks. To prompt banks into action, the 10% cap on investments in a single entity was removed. Banks were given a total of 45 days to find securities to invest in. The RBI further cut reverse repo rates by 25 bps to 3.75 in a bid to incentivise banks further. The 2% increase in interest on under deployment was kept intact, however. The result was still underwhelming. Of the notified 25000 crores , the number of bids received were only worth Rs. 12850 cr., making the bid to cover ratio just 0.5416. Banks hadn’t taken to the government’s shiny new policy.

Aside from re-enforced reservations about investing in low credit rated securities, banks had added issues with the meticulousness of the new policy. For instance, NBFCs with assets worth Rs 500 crores and below must be allotted 7500 cr. (15% of total funds) under new TLTRO guidelines. If an NBFC in that category needs 300 cr. to meet expenses, banks would need to invest in 25 such companies. Finding 25 such ( much more, in reality) investment grade bonds is difficult, even with an extension of 15 days. On the one hand, small companies are too diminished to soak allotted liquidity and on the other, the bid amount is not nearly enough to fund the bigger ones. For companies with asset size over 500 cr., only 12,500 cr. can be invested. This amount would only make a small dent in the expense amount of companies like Muthoot or Shriram. Even so, these few companies may find themselves hoarding the entire amount reserved for companies in that asset size.  Within that bracket of companies (500-5000 cr. assets) many would go without availing investment altogether, especially since the 10% cap had been revoked.

The government, till date has made efforts to fill in the gap that TLTRO left. the Finance Ministry on May 2020 announced the economic package 2.0 worth 75000 crores, of which 30000 crores is for enhancing liquidity through a special purpose vehicle (SPV) and another 45000 crores as partial credit guarantee scheme. PGCS covers the first loss of up to 10 per cent (revised to 20%) accrued by state-owned banks after investing in under-rated and unrated securities of NBFCs, HFCs, and MFIs.

So far, TLTRO has had two main objectives : 1. Jump starting the flow of liquidity into the bonds market and restoring the working of MFs in the process. 2. Assisting NBFCs and HFCs in overcoming their liquidity crisis. The first looks well within the bounds of achieving. With both versions of the policy, the bond market has seen increased trade flows. As for mutual funds, a lot of its re-activation will have to do with the state of the economy and the sentiments of the investors in the future. However, redemption amount can also be raised through TLTRO and prompt MFs into re-entering the bonds market. This option is much quicker than borrowing money from banks and will provide realisable assets before the six-month redemption period. As for the second objective, both versions of TLTRO signify the banks’ low appetite for risk- taking. And this, they cannot be denied, given the current environment brought on by the pandemic. To support weaker NBFCs, the RBI must either bear the risk itself through a more direct monetary policy or share the risk borne by the banks. Perhaps this could be done by extending credit guarantee schemes to cover more commercial banks along with larger first loss coverage. 

In conclusion, TLTRO is a fitting policy for the RBI to opt especially in the context of rising inflation in the economy where direct injections of liquidity are risky to apply. However, there are doubts as to whether it will be enough on its own. With more such monetary policies on the horizon, the future may still look promising and until then, TLTRO will suffice.

Definitions and Abbreviations:

1. TLTRO : Targeted Long Term Repo Operations

2. CPI : Consumer Price Index; measures changes in the price level of an average basket of consumer goods and services purchased by households.

3. bps : basis points ;

refers to a common unit of measure for interest rates and other percentages in finance.

4. Repo rate;

The rate of interest at which the central bank loans money to commercial banks

5. Reverse repo rate;

The rate of interest at which commercial banks park funds with the centra bank.

6. Liquidity;

Availability of cash in a market or a business

References:

1. Market financing conditions for NBFCs : issues and policy options

; by Rituraj, M Jagadeesh, Abhishek Kumar and Amit Meena

2. Monetary policy report, April 2020

3. www.rbi.org.in

4. Infomerics valuation and rating, April 25 2020

Some more things to check out:

1. One minute economics : a YouTube channel that simplified economic concepts and discusses current happenings.

2. Opinion has it : a podcast that invites distinguished economists to talk about economic issues around the world.

3. Poor economics : an earlier book by noble prize winning couple Esther Duflo and Abhijeet V. Banerjee. It discusses theories to overcome global poverty. A great read.

By-

Treesha Lall

(lalltrisha@gmail.com)