Liquidity coverage: Don’t add to the regulatory burden on banks

livemint.com:

RBI would review its liquidity coverage ratio (LCR) framework to ensure smooth functioning of the system even in the event of acute stress. His concern, he said, was driven by “recent events in other countries [that] have shown that digital channels have been used by customers to quickly withdraw or transfer funds from banks." Today, technology has enabled instantaneous transfers, with the result that banks are faced with a stiff challenge in managing their liquidity position to make sure they have sufficient cash at all times.

Under the Banking Regulation Act of 1949, banking is the business of taking deposits “repayable on demand." Hence, banks must always be able to honour any and all demands from customers for repayment. The governor stressed that it is during “acute stress" that a framework like LCR—a prudential tool to check a bank’s ability to meet cash outflows in the near future—is most needed.

While this is clearly true, a better option is to fool-proof the system in a way that minimizes the scope for such events, rather than wait for an implosion and then scramble to pick up the pieces. Presumably, RBI does not want to be caught napping, like some of its Western counterparts, and hence is proactively looking to ensure there is no liquidity crisis even during periods of acute stress.

This is welcome. After all, there is always space to fine-tune prudential regulations and get them up to speed.