Login With Google
Short-term rates rise as liquidity dries up
Why in the news ?
- The redemption pressure on mutual funds (MFs)and liquidity crisis at IL&FS have combined to trigger a liquidity deficit in the system.
- This led to short-term rates on commercial papers (CPs) increasing up to 50 basis points (bps) within a week.
More in the news
- The rate on three-month CPs is about 8.5%, up 40-50 bps as compared to a week ago.
- The rate on certificate of deposits of similar maturity is about 7.8%, up 20 bps.
- This prompted the RBI to announce to conduct open market operation (OMO) to purchase government bonds to infuse liquidity worth Rs.10,000 crore into the system.
- Banks and mutual funds are the main sources of funding for housing finance companies.
- Other NBFCs contributing about 40% and 30%, of their funding needs.
- With MFs becoming a key source of short-term liquidity, estimates suggest that the CPs of NBFCs have gone up three times since March 2016.
- MFs now reportedly hold 60% of total NBFC CP issuance.
Concepts
- Certificates of deposit and commercial papers are both instruments used in the money market for different financial purposes.
- A certificate of deposit (CD) is a document issued by the bank to an investor who chooses to deposit his funds in the bank for a specific amount of time.
- The interest paid to the depositor of a CD is higher than for a savings account.
- CDs issued by banks can be negotiable or non-negotiable.
- Commercial paper is a short term money market instrument that matures within a period of 270 days.
- Commercial papers are used as a means of raising funds.
- Commercial papers are not backed by collateral and, therefore, only creditworthy institutions with high debt ratings can issue them to obtain funds at a lower cost of interest.
- Open market operations (OMO) refer to the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system.
- RBI facilitates this process and uses this technique to manage the liquidity.
Source
The Hindu.