With an aim to reassure banks that long-term liquidity is available at a price that is reasonable given the state of the market and to further encourage banks to carry out maturity transformation comfortably and smoothly in order to increase credit flows to productive sectors, the RBI introduced long term repo operations (LTRO) in February 2020.
The LTRO is a framework that allows the central bank to lend money to banks for one to three years at the current repo rate in exchange for collateralized government assets with a similar or longer term.
This tool provides banks with liquidity for their one- to three-year requirements, in contrast to the RBI's present windows of liquidity adjustment facility (LAF) and marginal standing facility (MSF), which provide funds for their short-term needs of 1-28 days. LTRO operations are designed to stop the market's short-term interest rates from diverging significantly from the repo rate, which serves as the policy rate.
What are the main features of LTRO?
Banks would have to submit their requests at the current policy repo rate during the window timeframe for the amount requested under the LTRO. Bids that fall below or exceed the policy rate will be rejected. The minimum bid would be one crore rupees and multiples of that. No ceiling will be placed on the highest bid placed by any bidder.
The allocation will be made pro rata if there is an over-subscription of the announced amount. However, due to rounding issues, RBI reserves the right to inject a little amount greater than that which has been announced.
Since funds are given under LTRO at low interest rates, pressure may build on the total short-term interest rate to decrease. Similar to this, the short-term yield might decrease. Overall, the banking industry will under pressure to lower its lending rates.
LTRO enables the RBI to ensure that banks' marginal cost of funds-based lending rates are lowered while policy rates are left unaltered. It also shows the market that RBI's monetary policy would use new methods in addition to changing repo rates and conducting open market operations to accomplish its objectives.
Analysts have termed LTRO a "masterstroke." In addition to decreasing rates at the short end of the sovereign curve, LTRO is anticipated to slash corporate bond yields, deposit rates, and lending rates. It is considered a step in the direction of credit transmission and shows the RBI's commitment to expansion.
