Home » Banking tremor caused by CB Governor – New money printing to bailout banks?

Banking tremor caused by CB Governor – New money printing to bailout banks?


The public panic created by the 5-day banking holiday (29th June to 3rd July) announced by the CB Governor in the night of 25th June is now not a secret. The purpose of the banking holiday was stated as required to keep the banking and markets stable to facilitate the proposed domestic debt restructuring/optimization approval process of the Parliament.

Whenever there are panic-driven transactions and tremors in the banking sector, banks face stress liquidity conditions or liquidity crunches. Five sources that banks resort to raise the liquidity or funds during normal times are as follows.

  • Use of excess cash available at hand
  • Borrow from the inter-bank market
  • Sell investments in government securities in the secondary market
  • Borrow from the overnight standing lending facility of the Central Bank
  • Borrow from the reverse repo auctions if announced by the Central Bank

What happened during the last three days 26-28 June

The limited data published by the CB shows early warnings of a liquidity crunch that may pull a trigger of a systemic risk unless relevant authorities resolve financial problems presently confronted by banks consequent to foreign currency and debt crisis and severe macroeconomic contraction caused by the monetary policy.

Out of above five sources, data show the heavy use of sources other than the sale of government securities. The inactivity in the government securities market due to domestic debt restructuring pending and the mark-to-market losses on investments in government securities due to sugar high interest rate policy of the Central Bank are the major reasons for not using the source of the sale of government securities.

The use of other four sources is highlighted below.

  • Use of excess cash

Banks generally deposit their excess cash overnight at the CB at interest rate of 13% at present. However, banks have cut such deposits and used excess cash for liquidity purposes. Accordingly, the volume of such deposits immediately declined to Rs. 15 mn on 26th and 32 bn on 27th as compared to Rs. 182 bn on the previous day. However, such deposits have risen back to Rs. 218.6 bn on 28th as a part of investment because banks can earn interest of 13% on these deposits during the special 5-day bank holiday without any risk.

  • Borrow from the inter-bank market

Inter-bank borrowing rose to Rs. 7.8 bn on 26th from Rs. 5.9 bn previous day. However, such borrowing declined to Rs. 5.1 bn on 27th and zero on 28th. Lower or zero inter-bank lending could be a result of banks not lending to other banks due to confidence problems generally seen during bank problem times.

  • Borrow from the CB’s overnight standing lending facility

As this facility is subject to a cap of 90% of bank statutory reserve requirement, banks are not free to access the facility. At present. these loans are given at a rate of interest of 14% with government securities taken as collateral.

Accordingly, the use of this facility was Rs. 128.6 bn on 26th, Rs. 117.3 bn on 27th and Rs. 218.6 bn on 28th. The low volume is due to the cap.

  • Borrow from the reverse repo auctions announced by the CB

The general policy of the CB is to announce reverse repo auctions to banks as and when the CB finds shortages of banking sector liquidity. Reverve repo lending is granted against collateral of government securities and can be for overnight or for several days (term reverse repo).

The CB has offered one overnight auction and one short-term auction each day, 26th, 27th and 28th, for a total of Rs. 310 bn and Rs. 180 bn, respectively. Accordingly, the CB has lent Rs. 205.25 bn and Rs. 119.7 bn, respectively, with a total of Rs. 324.95 bn.

A summary of these auctions is as follows.

Highlights on the summary are as follows.

  • Expecting liquidity stresses, the CB has announced auctions of more supply than demand. The total supply was Rs. 490 bn as compared to the total demand of Rs. 464.5 bn.
  • The volume auctioned has risen daily as the CB expected rising liquidity tremors among banks.
  • In four auctions, the weighted average yield was lower than the standing lending facility rate of 14%. Therefore, banks were better-off at a loss to the public funds. Banks who got minimum yields in the range of 13.35%-13.55% had more favourable deals. The loss to public funds on these reverse repo lending was 0.16%-0.33%.
  • Funds in two 7-day auctions were provided at an interest of 14% which is same as overnight lending facility rate whereas bids accepted from each auction are seen as facilitation of one bank (as all three yields are same). 7-day lending at the same rate of overnight lending at a time of liquidity shortages is a major concern over the negligence of the management of public funds.
  • Direct borrowing of Rs. 360.7 bn from the CB on 26th against the sale of Treasury bills/bonds.

In addition to above sources, the CB has implemented LOLR facility too. The CB’s holding of Treasury bills/bonds has risen to Rs. 2,817,071 mn on 26th. This is a record increase of Rs. 360,734 mn from the holding on last Friday. In the past, the reason for the increase/decrease in this holding has been the CB’s lending to the government through direct purchase of Treasury bills. However, the CB has not made any specific direct issuance of Treasury bills to itself on 26th. 

Therefore, it appears that the CB has provided LOLR funds to some banks upon the discount or outright purchase or swap of Treasury bills and bonds. This has become necessary as the CB has imposed a cap on overnight standing lending facility. As the interest rate charged or the type of lending are not revealed or transparent, the loss to the public funds on this colossal transaction cannot be traced.

Concluding Remarks

  • Information highlighted above shows the adverse impact felt by banks on their liquidity conditions consequent to the unjustifiable bank holiday of strait 5 days announced abruptly by the CB’s Governor on 25th June midnight.
  • According to the PowerPoint presentation made by the CB Governor to the Cabinet of Ministers on 28th June, the banking sector is in a vulnerable financial condition as seen from some highlights of the presentations as follows (see the slides at the end of the article). This is a complete U turn of the CB’s recent assurance that the banking sector is safe and sound in terms of the liquidity and capital of the banking system. Further. the CB Governor assured in his press statement that deposits were safer and unaffected by the debt restructuring.
  • Banking sector has already borne a significant burden of the fiscal adjustment and the economic crisis in several ways (Slide 22).
  • Banking sector is already facing significant stress amidst the economic crisis.. Banking sector nonperforming loans have increased substantially, there is already a need for high provisioning and capital enhancement, these would affect banking sector performance and profitability (Slide 23).
  • Foreign currency debt restructuring will result in a notable impact on the banking sector (Slide 24).
  • Amidst this bank vulnerability of systemic nature, the CB Governor’s abrupt press statement on 5-day bank holiday has further added to the vulnerability through a public panic over the safety of their deposits as seen form the distress liquidity shown above. The rationale for the panic is well established from the CB Governor’s presentation itself.
  • The CB Governor or his team or other state authorities or their supporters have no knowledge of the interconnectedness and inter-dependence of the government, banks, financial institutions, markets, businesses, households and individuals through debt/credit in a chained manner. There is enough evidence that the chain is broken at several points such as default of government debt and non-performance of bank loans.
  • As the Cabinet of Ministers and members of the Parliament have now been officially informed of the banking sector vulnerability, they have to act promptly to correct the situation before being too late for the risk of contagion of the present foreign currency and debt crisis to the domestic currency crisis, given the fact that the monetary and financial system are built on public debt and banking sector.

(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures.)

P Samarasiri

Former Deputy Governor, Central Bank of Sri Lanka

(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 10 Economics and Banking Books and a large number of articles published. 

The author holds BA Hons in Economics from University of Colombo, MA in Economics from University of Kansas, USA, and international training exposures in economic management and financial system regulation)

Source: Economy Forward

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