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Liquidity Shortage



  Aug 29, 2023

Liquidity Crunch


A liquidity crunch is a situation in which there is a shortage of available funds in the financial system. It can lead to difficulty in borrowing and lending, potentially causing higher borrowing costs and impacting overall economic and financial activities.
 

Q: What's causing the banking system's liquidity crunch?

A: Multiple factors contribute, including the Incremental Cash Reserve Ratio (I-CRR) introduction, tying up bank deposits, GST payments, and high credit demand, creating a liquidity deficit.
 

Q: How are banks and NBFCs managing liquidity amidst the crunch?

A: They're raising short-term funds via Certificates of Deposit (CDs) and commercial papers (CPs). CD rates rose due to I-CRR and credit growth, while CP rates also increased.
 

Q: How did the I-CRR announcement affect liquidity and rates?

A: It led to increased short-term fund demand, raising rates. Anticipation of I-CRR extension heightened the crunch. Banks and NBFCs offer higher rates on short-term liabilities.
 

Q: How did call money and CP rates react to the liquidity situation?

A: Call money rate rose above the repo rate, signifying tightened liquidity. Issuing CPs raised rates.
 

Q: What's the outlook according to market participants?

A: Rates might stabilize in September as government spending increases, but advance tax payments could tighten liquidity, causing elevated rates for around 1.5 months. Improvement hinges on liquidity adjustments and external factors.
 

Q: How might this liquidity crunch impact the economy and markets?

A: It could raise borrowing costs, impacting lending and economic activity. Central bank and government actions will be crucial in managing broader impacts.
 
Certificate of Deposit (CD): A short-term debt instrument issued by banks to raise funds from investors, offering fixed interest rates for a specified maturity period.
 
Commercial Paper (CP): Short-term unsecured promissory notes issued by corporations to meet immediate financing needs, providing an alternative source of short-term funding in the money market.
 
Call money market: The call money market refers to the market where banks lend and borrow funds on an overnight basis. It plays a crucial role in managing short-term liquidity needs and influences short-term interest rates in the financial system.


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