Bankers await signs on Indian cenbank's liquidity approach amid persisting disconnect

By Ira Dugal and Dharamraj Dhutia

MUMBAI (Reuters) - The Reserve Bank of India's policy review on Thursday will be closely watched for cues on its approach towards liquidity, even as policy interest rates are likely to remain unchanged, at least three bankers said.

Banks in India have been reluctant to park their surplus liquidity with the Reserve Bank of India (RBI) for longer periods of time to avoid the risk of a potential shortfall - an approach the RBI would like changed as surplus money in the system could potentially prove inflationary.

Last week the RBI offered to withdraw 2 trillion rupees via 14-day variable rate reverse repo auctions - the preferred tool to absorb liquidity for longer periods - after the banking liquidity surplus swelled to 2.4 trillion rupees ($29.06 billion). Banks, however, parked just a fourth of that amount.

A second VRRR auction of 1 trillion rupees was announced on Monday - this time for just 4-days, but was not fully subscribed.

The liquidity surplus on Monday was 2.3 trillion rupees.

"Banks are not parking funds with the RBI because they are unsure about how long the surplus liquidity will last," said Soumyajit Niyogi, a director of the core analytical group at India Ratings & Research.

"They would rather give up earning a few extra basis points on their surplus than risk a shortfall due to unanticipated swings in liquidity," he said.

Earlier in May, overnight rates spiked after the liquidity surplus dropped unexpectedly, forcing banks to borrow from the market.

A treasury official at a large private bank said that apart from unpredictable government spending and forex market intervention, a recent decision to withdraw 2,000-rupee denominated notes was among factors that have added to the volatility.

"There is an opportunity cost for banks to park that liquidity for 14-days because they give up options to invest this elsewhere such as in treasury bills," the official said, declining to be identified as he is not permitted to speak to the media.

The 91-day T-bill yield remains above 6.75%, while commercial paper of state-run companies offers around 6.95%.

Some banks are also reluctant to tap the central bank's marginal standing facility (MSF), where it offers funds if banks run short of liquidity, as their boards and auditors tend to question the use of the high-cost fall-back facility, the banker quoted above said.

"PSU banks want to avoid using MSF ...(and) choose to keep funds with them and go for the lowly-rewarding standing deposit facility (SDF)," treasury head of a state-run bank said.

Communication from the central bank to "de-stigmatise" the MSF window will help, the private bank official said.

The repo rate stands at 6.50%, while SDF and MSF stand at 6.25% and 6.75% respectively.

Another official at a private bank said overnight VRRR would be welcome but the central bank may be reluctant to offer it. The RBI and banks were "feeling their way through" the current liquidity condition, he said.

($1 = 82.5790 Indian rupees)

(Reporting by Ira Dugal and Dharamraj Dhutia in Mumbai; Editing by Nivedita Bhattacharjee)