The Reserve Bank of India (RBI) has mandated banks to create aside a portion of their deposits as statutory liquidity percentage (SLR) or the minimum amount it must hold within gold, cash or government bonds. In addition, banks need to set aside a portion of their deposits as cash using the central bank, a requirement called the cash reserve percentage.
These reserves can act as a liquidity buffer with regard to banks during crisis time.
"SLR at 24%, CRR at 6% continues to be considered high. At some point it [CRR, SLR combined] was 65% and today it is 30%, " said RBI Governor Duvvuri Subbarao in his address in the National Finance Symposium organised by the Indian Institute associated with Foreign Trade.
"It is our objective in RBI to create it down but in a calibrated way. "
Government bond yields rose after Subbarao's comments on the requirement to lower SLR on concerns that such a move could prompt banks to offload a number of their bond holdings. The minimum regulatory requirement acts the captive demand for government bonds.
The 10-year benchmark bond yield rose by one basis indicate 8. 29% after the comment. It closed at 8. 28% upon Monday.
"Though it is RBI's medium term goal to lessen SLR and CRR, in a knee-jerk reaction, yields went up because they [traders] were worried that RBI may cut SLR in order to infuse liquidity, " said a dealer at a international bank.
Currently banks' overall holding of SLR bonds is about 29%, according to analysts.
The central bank had last reduced the SLR by one percentage indicate 24%, effective December 18, 2010, to ease acute rigidity in liquidity.
Subbarao said that the SLR requirement had help protect Indian banks throughout the global credit crisis and the new global banking rules under Basel III possess a provision which mimics the SLR rule.
Yet, the central bank chief said that some decrease in the ratio may be needed.
"We should bring it (SLR) down to ensure that credit is available and so that private sector isn't crowded out, " Subbarao said on the sidelines from the event.
The RBI has also not tinkered with CRR because April 2010, when it had last raised the book ratio by 25 basis points to 6%.
The RBI governor also said how the central bank is looking at relaunching inflation indexed provides.
"We are looking at reintroducing inflation indexed bonds. One concern obviously is, in a period of relatively high inflation there are, whether it will be successful. We will think via this, but we will certainly introduce it. "
Inflation indexed bonds are floating rate bonds from the inflation rate and such bonds help investors to protect their investments from mark-to-market volatility.
However, an investor will want to consider buying such bonds only when they expect inflation to increase further going ahead unlike now, when most expect prices to cool-down in next few months.