Long Term Repo Operation (LTRO)

2020 MAR 10

Preliminary   > Economic Development   >   Indian Economy and Issues   >   Monetary policy

In news:

  • To enable better transmission of its monetary policy, the Reserve Bank of India (RBI) has introduced Long Term Repo Operations (LTRO).

About LTRO

  • The LTRO is a tool under which the central bank provides one-year to three-year money to banks at the prevailing repo rate, accepting government securities with matching or higher tenure as the collateral.
  • While the RBI’s current windows of liquidity adjustment facility (LAF) and marginal standing facility (MSF) offer banks money for their immediate needs ranging from 1-28 days, the LTRO supplies them with liquidity for their 1- to 3-year needs.
  • LTRO operations are intended to prevent short-term interest rates in the market from drifting a long way away from the policy rate, which is the repo rate.
  • It is a measure that market participants expect will bring down short-term rates and also boost investment in corporate bonds.
  • These new measures coupled with RBI’s earlier introduced ‘Operation Twist’ are an attempt by the central bank to manage bond yields and push transmission of earlier rate cuts.

Why is it important?

  • Ever since the economic slowdown hit India and the IL&FS fiasco triggered a spike in borrowing costs, the RBI has been trying to stimulate the economy through easy-money policies.
  • Since January 2019, the repo rate (the rate at which banks borrows quick money from RBI) has been cut by 139 basis points. But only a part of these rate cuts has as yet been passed on to borrowers by banks and other lenders.
  • When charged with this slow transmission of rate cuts, bankers complained that repo loans constituted only a miniscule portion of their overall funds, making it difficult for them to cut lending rates.
  • Under the LAF, banks could only bid up to a maximum of 0.75 per cent of their net demand and time liabilities.
  • The LTRO bidding system, taken with the removal of the 0.75 per cent limit on LAF borrowings, is expected to remove these constraints.
  • The RBI believes that offering banks durable longer-term liquidity at the repo rate (5.15 per cent), can help them lower the rates they charge on retail and industrial loans, while maintaining their margins.
  • The encouraging response to the first auction indicates the banks’ high appetite for cheap funds — bids were received for more than 7.7 times the amount auctioned (?25,000 crore).
  • The LTRO will also help bring down the yields for shorter-term securities (in the 1-3-year tenor) in the bond market.

PRELIMS QUESTION:

Q. Which of the following are the potential implications of Long Term Repo Operations (LTROs)?

1. It can bring down the short-term interest rates

2. It can boost investment in corporate bonds

Select the correct answer using the code given below:

a. 1 only

b. 2 only

c. Both 1 and 2

d. Neither 1 nor 2

Answer to Prelims question