Thread by @theGayan

Déjà Vu: SDF restrictions are back!

@CBSL restricted access to its Standing Deposit (SLF) and Standing Lending Facility (SLF) to Banks.

Last time this happened was in Sep 2014.

Let me tell you:
• Why?
• What?
• How?
in a simple way.

1/13
@CSE_Media #EconomicCrisisLK

https://twitter.com/theGayan/status/1610107582806659075

What is SDF/SLF?
SDF: banks can park their excess money on an overnight basis. SDF Rate now is 14.5% p.a.

SLF: banks can borrow money on an overnight basis, to meet their liquidity needs. SLF Rate now is 15.5% p.a.

Collectively, SDFR and SLFR is called "CBSL policy rates".
2/13

What’s the role of SDF?
Banks with excess money (usually) lend to other banks, at a rate higher than SDFR.

This is because they can earn SDFR simply by depositing at CBSL.

After lending, any excess money that remains, they'd park at CBSL SDF.

3/13

What’s the role of SLF?
Similarly, a bank in need of money would first try to borrow from the interbank market, at a rate lower than SLFR.

This is because they can anyway borrow at SLFR from CBSL.

4/13

What’s actually happening in the interbank market?

As of today (04th Jan):

SDF 349 Bn (banks deposited with CBSL at 14.5% p.a.)
SLF -553 Bn (banks borrowed from CBSL at 15.5% p.a.)
Net -204 Bn (net liquidity deficit in money market)

5/13

Why would banks deposit Rs. 349 Bn with CBSL at 14.5%, when they could’ve lent that money to other banks at, say, 15%?

This is because “some” banks are NOT lending to other banks.

Why??
Due to various reasons, interbank limits of some banks have been scrapped.

6/13

So, rather than lending to other banks (at higher rates), they are compelled to place their excess money in SDF.

On the flip side, banks with liquidity shortfalls are now compelled to borrow (more) from CBSL SLF, at a higher rate.

7/13

What happens with this SDF restriction?
Now, access to SDF is limited to 5 times in a calendar month.

Most likely, banks will use SDF on Friday’s to cover more ground (Friday is counted for 3 days).

Still this leaves about 15 - 18 days where they won’t earn any interest.
8/13

What are the other options available to such banks?
• lend to other banks
• lend to customers (not practical)
• buy short-term T Bills

Actual course of action will depend on banks' internal views/restrictions.

Also, there'll be a lead time to obtain such approvals.

9/13

Why SLF was limited to 90% of SRR?

Recall that SLFR is 15.5%.

Now, compare this with 3 months T Bill rate which is 32%.

This provides an arbitrage opportunity for banks:
• Keep borrowing from CBSL SLF at 15.5%
• Invest in 3 months T Bills at 32%

10/13

Yes, there’s a big maturity mismatch: overnight funding vs. 3-month investment.

But given a net interest spread of over 15%, this strategy would always generate a profit.

Now that SLF is restricted to 90% of SRR, possibility of such arbitrage is eliminated.

11/13

TL;DR
• "some" banks were not lending to others
• this created a liquidity mismatch
• CBSL restricted SDF access to encourage interbank lending
• an arbitrage opportunity existed between SLFR (15.5%) & 3M T Bills (32%)
• CBSL restricted SLF access to eliminate this

12/13

That’s it. Now you know all about SDF, SLF and what the new CBSL restrictions means.

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