Rupee liquidity in banks ‘different from normal’: Central Bank

By Sanath Nanayakkare

With the spike in policy interest rates, rupee liquidity in the banks is different from what is normal, Yvette Fernando, deputy governor of the Central Bank said at a webinar hosted by the Centre for Banking Studies of the Central Bank.

“According to the reports we have received, the current rupee liquidity in the banks has not caused any distress to their daily transactions. However, in an increased rate environment, sometimes customers switch banks to get higher rates and some even opt to use their deposits to purchase Treasury Bills that earn them higher yields. This is normal when there’s a significant change in interest rates. You know that banks take deposits from customers and invest these funds in various ways to help the growth of the economy, while assuring security and reward to depositors. However, when such significant changes are made to the exchange rate policy and interest rates, banks feel the impacts of these policy decisions on their investment decisions.”

She made these remarks in response to a question from the audience whether the lifting of the fixed exchange rate regime and eye-popping numbers in interest rates could destabilize the banking system.

Elaborating on this particular concern among the public, she said, “Even before the most recent interest rate hike and flexible exchange rate policy, banks encountered stress due to lack of foreign currency in the past 12-18 months. Their foreign remittances base declined and their foreign inflows dropped after Sri Lanka’s credit ratings were downgraded by international ratings agencies. Under such circumstances, the banks had to make loan repayments. New loans couldn’t be taken and existing loans could not be renewed. Some banks were inconvenienced in inter-bank settlements as their foreign inflows were inadequate. The Bank of Ceylon and People’s Bank that provide substantial funds to finance the import of fuel, LP gas, medicines and other essential commodities also felt a significant impact as a result of these developments. That situation led the two state banks to collaborate with other banks to facilitate the critical shipments where the Central Bank also intervened when necessary.”

“Now, the most recent interest rate hike and exchange rate policy have had an even more significant impact on the banks’ assets and responsibilities. However, the capital and liquidity buffers of the banks are at optimal levels and have helped them to operate resiliently despite the impact on their rupee liquidity.”

The deputy governor went on to say that if the need arises to support the banking system with rupee liquidity, the Central Bank can do so within the regulatory provisions made available to it.

“We have the ability to intervene and provide that facilitation within that lawful framework. We are always prepared to do that. Even the Monetary Board of the Central Bank is aware of this situation,” she said.

“We recently allowed the banks to operate within a new space of facilitated prudential requirements in line with their assets and responsibilities. I believe that within a short period of time, the adjustments in the macroeconomic framework and measures taken by the government and the central bank will help boost foreign reserves and significantly ease these inconveniences. Thus the banks will be able to operate just as in normal conditions. This will take about a month or two to materialize. Of course, to achieve that, confidence in the Sri Lankan economy needs to be restored. A program with the IMF will help restore that confidence which in turn should revive the foreign exchange market, creating a more comfortable situation for banks to operate,” she said.

Meanwhile, Prime Minister Ranil Wickramasinghe said on Tuesday that Sri Lanka doesn’t have any rupee income, and by the end of the year the rupee crisis would be solved with the introduction of taxes.