Central Bank restricts banks from parking funds with the banking regulator

The Central Bank has announced limits by which commercial banks can avail themselves from depositing funds in the banking regulator, in a measure to ease a shortage of liquidity in the banking system.

These measures were announced on Saturday.

Under the present scheme, local and foreign banks would inject around Rs. 600 billion daily under the overnight standing facilities where the Central Bank absorbs funds from the market at 14.5 per cent interest and lends to the market (whenever there is a shortage) at 15.5 per cent.

Bankers said the new rule announced on Saturday came because banks, instead of lending in the inter-bank market, were depositing funds (at a more lucrative rate) with the Central Bank and thereby leading to a shortage of liquidity (around Rs. 300 billion) daily.

As per the new rule, with effect from January 16, the Standing Deposit Facility (SDF), the overnight deposit facility that allows banks to park excess liquidity and earn interest, will be limited to a maximum of five times per calendar month. At the same time, the Standing Lending facility (SLF), which is the collateralised facility provided for banks to fulfill any further shortage of the liquidity requirements from the Central Bank at the end of the day, would also be limited to 90 per cent of the Statutory Reserve Requirement (SRR) of each bank at any given day, the statement said.

It said the liquidity deficit in the domestic money market, which remained significantly high during the first half of 2022, declined in the latter part of 2022. However, in spite of the improvements in money market liquidity conditions, market interest rates continued to remain high, partly due to subdued activity in the domestic money markets. At the same time, it has been observed that several banks have continued to depend excessively on the overnight Standing Facilities without considering market based funding options to address their structural liquidity needs. “Such banks have not indicated any signs of taking remedial actions to reduce the over dependence on overnight facilities offered by the Central Bank, which are available to be used as fall back options after utilizing all other funding options. Such behaviour of banks affects the efforts of the Central Bank to reactivate the money markets, primarily the interbank call money market and the repo market, while posing a threat to smooth channeling of funds in the economy with a possibility of clogging the payment and settlement systems,” the statement said.

Accordingly the Central Bank has decided to impose restrictions on the availability of the Standing Facilities to banks.

The imposition of the limitations on the Standing Facilities is expected to reduce over dependence of banks on the overnight facilities offered by the Central Bank and support the reactivation of the domestic money market, which remained nearly inactive for the last few months, while encouraging banks to transact among themselves. “These measures would also eliminate unhealthy competition for deposits among financial institutions and would be instrumental in inducing a moderation in the market interest rate structure (of both deposit and lending interest rates) in the period ahead along with improving market liquidity conditions, which will help to restore stability of the Sri Lankan economy, while preserving stability of the financial system,” the banking regulator said.