India’s Cash-Rich Banks Find Easy Profits in Rate Gap

A sharp surge in liquidity across India’s banking system has created a lucrative arbitrage opportunity for lenders, allowing them to borrow funds at lower rates and park the money with the central bank at a higher return. Overnight money market rates have tumbled after the Reserve Bank of India (RBI) injected significant liquidity into the system, aided by increased government spending. As a result, the tri-party repo (TREPS)—the most liquid short-term funding instrument—has fallen well below the RBI’s Standing Deposit Facility (SDF) rate of 5%, where banks can park surplus overnight funds. The spread between the two rates widened to 34 basis points on Wednesday, and had touched as much as 75 basis points last week, making the trade highly profitable,

said a Bloomberg report.Instead of deploying excess funds into business lending, banks are increasingly taking advantage of this rate gap.“Banks don’t need the surplus liquidity for their own balance sheet and are placing the TREPS proceeds on the SDF window,” said Nathan Sribalasundaram, rates strategist at Nomura Holdings Inc. “Banks are making money from this, given excess liquidity.”Data from the RBI shows that funds parked by banks with the central bank surged to a record Rs 5 trillion last week, compared to just Rs 1.4 trillion two weeks earlier.The liquidity situation marks a dramatic turnaround. Just two months ago, conditions were tight. Now, the system is experiencing its largest surplus in six months.The RBI has so far refrained from draining excess short-term liquidity, raising questions about whether it is deliberately allowing easier financial conditions to ensure effective transmission of earlier rate cuts into the broader economy.However, market participants expect the opportunity to narrow soon.“Financial markets every year provide such temporary opportunities and it is normal,” said Sagar Shah, head of domestic markets at RBL Bank Ltd. He added that rates are likely to move higher toward the end of February as liquidity tightens due to tax-related outflows, with conditions expected to remain strained in March, the financial year-end.