LTRO: Long Term Repo Rate Operations | Explained

• 1 May 2020 | 1783 Views | By

Long Term Repo Rate Operations or LTRO have proven to be a prominent tool to infuse liquidity into the economy of a country. Having originated in the year 2008, this central bank tool has been widely accepted by major central banks all over. But how does it work? When is it needed? How is it implemented? We answer these questions and more in this article.

We are amidst a phase of a global financial crisis due to the outbreak of COVID 19. COVID-19 sparked large sell-offs in the domestic equity, bond, and the forex markets, thus leading to an upsurge in redemption pressures. Central banks all over the world like the U.S. Federal Reserve and the European Central Bank have been continuously interacting with the financial markets and have taken many unconventional measures to stabilise the market framework.

Read about the impact of Coronavirus on the economy.

Infusing Liquidity in the Market

The Reserve Bank of India, which is the apex body for financial institutions in India, too has taken many harsh steps under the current disruptive situation to ensure that the effects of the COVID-19 pandemic on the Indian economy are mitigated and that financial markets and institutions continue to function normally. 

Hence, to combat the crisis caused by COVID-19, RBI along with other rate cut measures introduced a tool called Long Term Repo Operation (LTRO) to inject liquidity in the system, as well as to ensure the transmission of rates. RBI introduced LTRO with a view to comfort the banks about the accessibility of liquidity at reasonable cost compared to prevailing market conditions, and additionally to support the banks to undertake maturity transformation efficiently and seamlessly so as to augment credit flows to productive sectors. It is expected by the market participants that this step will bring down short-term rates and also boost investment in corporate bonds.

To understand what LTRO is, let us first understand the meaning of repo.

What is Repo Rate Meaning?

Repo is the short abbreviation for repurchase agreement. It is a form of short-term borrowing for traders in government securities. In the case of repo, a dealer sells government securities to investors, commonly on an overnight basis. They then buy them back the following day at a slightly higher price. That slight variance in price is the implicit overnight interest rate. Hence in the Indian context, the repo rate is the rate at which the Reserve Bank of India lends money to commercial banks in the event of any shortfall of funds.

Repos are typically used to raise short-term capital. Monetary authorities to control inflation also use it. Repo rate is a dominant arm of the Indian monetary policy that can control the country’s money supply, inflation levels, and liquidity. Furthermore, the levels of repo have a straight impact on the cost of borrowing for banks. Thus higher the repo rate, the higher will be the cost of borrowing for banks and vice-versa.

What is LTRO?

To counter the economic impact and successive pressure on cash flows, the reserve bank decided to conduct auctions of targeted term repos of up to three years tenor of adequate sizes for a total amount of up to Rs 1 lakh crore at a floating rate linked to the policy repo rate. Simply speaking, under LTRO the RBI provides longer-term loans, ranging from one month to three years, to banks at the prevailing rate. Usually, loans with higher maturity periods (in this case like 1 year and 3 years) will have a higher interest rate compared to short-term (repo) loans. The resultant of this is the reduction in the cost of funds, as banks get long-term funds at lower rates.

The European Central Bank first introduced LTRO during its sovereign debt crisis that began in 2008. LTROs provide banks with access to cheaper capital from the RBI. This, in turn, encourages them to lend more and spur economic activity. They can also invest these long-term funds in assets that yield better returns to improve profitability.

Timeline of LTRO

Many of us may be aware that the banks haven’t been passing down the RBI’s rate cuts to the borrowers. Thus to countermeasure this, the RBI took certain steps to drive up monetary policy transmission in its recent monetary policy review in February 2020. The Reserve Bank of India decided to conduct this in the following 4 phases:

How will LTRO work?

Phase 1

The response to the LTRO had been highly encouraging. The total amount of bids had exceeded the aggregate amount of Rs. 1,00,000 crore proposed to be offered under the LTRO scheme. The allotment was done for all bids on a pro-rata basis and total bids that were received amounted to Rs. 1,94,414 crore had been allotted Rs. 25,035 crore on a 12.86% basis.

Phase 2

This too was oversubscribed and the total bids received amounted to Rs.1,23,154 crore. The allotment was done pro-rata basis amounting to Rs. 25,021 crores on a 20.30%.

Phase 3

The total bids that were received amounted to Rs.1,71,965 crore and the allotments were made for Rs. 25,028 crores at 14.54%.

Phase 4

This again was oversubscribed and the total bids received amounted to Rs. 48,856 crore and the allotments were made for Rs. 25,021 crores at 51.18% basis.

Later on, looking at the market conditions and with a view to further improving monetary transmission, it had been decided by the RBI to conduct additional Long Term Repo Operations (LTROs) for up to a total amount of Rs. 1,00,000 crore at the policy repo rate. This too would be carried out in phases 

The details for subscription to this and further phases are yet to be released by RBI.

Guidelines

These LTROs are in addition to the RBI’s policy of existing liquidity adjustment facility (LAF) and marginal standing facility (MSF) operations. These LTROs will be conducted on CBS (E-KUBER) platform. The operations would be conducted at a fixed rate. The banks would have to place their requests for the amount sought under LTRO within the window timing at the prevailing policy repo rate. The bids placed below or above the policy rate would be rejected. The minimum bid amount would be Rupees 1 crore and in multiples thereof. There would be no restriction on the highest amount of bidding by individual bidders.

Why did RBI introduce LTRO?- Objectives and importance of LTRO

Long Term Repo Operation is fundamentally a mechanism to inject liquidity into the banking system as well as to ensure the smooth and efficient transmission of monetary policy actions and flow of credit into the economy.  This helps the banks as banks get long-term funds at lower rates, their cost of funds falls thus, in turn, they reduce interest rates for borrowers. LTRO also helped RBI in ensuring that the banks reduce their marginal cost of funds-based lending rate, without reducing policy rates.

An interesting feature to look at would be, as the funds through LTRO will be provided at the repo rate, this means that banks can avail one year and three-year loans at the same interest rate as of one day repo. If the RBI is ready to give one-year and three-year loans at the low repo rate, then there will be a clear pressure on banks to reduce their lending rates. Hence, the most important effect of the LTRO in the system will be a decline in short term lending rates of banks. 

Concluding words

The 2008 world’s financial crisis was a global economic calamity and the fear of crisis to be caused by COVID -19 is quite unknown yet. The long-term impact on the economy can be controlled to be less severe than the financial crisis if the governments and regulators act quickly to contain the economic fallout. As India has now entered into the second phase of a nationwide lockdown to combat coronavirus, many strict and harsh measures will have to be taken up by the policymakers to protect the Indian financial economy. 

In the past too RBI has invoked policy of LTRO as a measure in extenuating circumstances and made it clear that it is not only some traditional steps like cutting repo rate or open market operations that the bank will do, rather it can invoke some other policy measures to achieve its desired objectives too. The announcement of LTRO also acts as a measure that brings down short-term rates and boosts investment in corporate bonds. As part of the second COVID-19 rescue package, and specifically, to ease liquidity for NBFCs, the RBI on April 17 had also announced TLTRO 2.0 worth an initial amount of Rs 50,000 crore.