* 10-yr bond yield up as much as 15 bps
* Bank shares skid; SBI down 1.5 pct
* RBI announces temporary hike in cash reserve ratio
* Action comes as RBI under political scrutiny
(Updates with quotes, details, background)
By Rafael Nam and Savio Shetty
MUMBAI, Nov 28 (Reuters) - Indian bonds and banking shares
slumped on Monday after the Reserve Bank of India ordered banks
to temporarily increase their cash on deposit at the RBI to
absorb excess liquidity caused by a government ban on
The benchmark 10-year bond yield rose as much
as 15 bps at one point, while the overnight call rate surged to
14.4 percent from its 5.90 percent close on Friday.
The Reserve Bank of India had been forced to act, according
to traders, after Prime Minister Narendra Modi's shock move on
Nov. 8 to abolish 500 and 1,000 rupee notes had sparked a surge
in deposits of the old notes at banks.
Lenders, in turn, had plowed this cash into government
bonds, sparking a rally in debt markets that analysts had warned
could not last once people started withdrawing cash, a
particular concern because the rupee had hit a record
low last week as emerging market currencies fell.
Analysts also noted the RBI had to act because it was
running short of government bonds that it could offer as
collateral under its reverse repo arrangements.
The move comes as the RBI's supervision of the massive
operation to deal with the abolition of 86 percent of the notes
in circulation has come under increased criticism from Modi's
political opponents, including formr Prime Minister Manmohan
Singh last month.
The RBI has announced a range of measures to ease the pain
from its measures, but analysts say the RBI should have planned
more effectively, rather than reacting to events.
"They have been doing a good job ironing out the kinks as
they become apparent," said Varun Khandelwal, founder of Bullero
"However, the RBI was definitely behind the curve in failing
to expect massive buying of bonds by the banking system. Their
circular placing a 100 percent cash reserve requirement (CRR) on
fresh deposits should have come on the 8th or 9th November, not
on the 26th (of November)."
The RBI said on Saturday that banks would need to transfer
100 percent of the deposits generated between Sept. 16 and Nov.
11 with the RBI, saying it was a temporary measure that would be
reviewed on or before Dec. 9.
The move is likely to drain over 3.24 trillion rupees
($47.29 billion) from the banks, according to Reuters estimates.
The RBI will review its decision once the government has
issued an adequate amount of market stabilisation scheme bonds
to soak up liquidity, Governor Urjit Patel was quoted as telling
the Press Trust of India on Sunday, in his first interview since
his appointment in August.
Banking shares skidded on Monday, with State Bank of India
down 1.5 percent, given that the RBI's requirements
would deprive banks of the interest earned on funds deposited
with the RBI.
The RBI's action could also cut short a rally in bond markets
that has seen the 10-year bond yield fall more than 50 bps to a
more than 7-1/2 year low. The yield was last up 7 bps at 6.30
Emerging market assets have tumbled since Donald Trump's
election to president on expectations he will pursue an
expansionary fiscal policy that will drive up inflation and lead
to higher U.S. interest rates.
The RBI's banknote action comes ahead of its policy review
on Dec. 7. Analysts say there is a growing possibility the
central bank will cut interest rates by 25 bps given that the
abolition of the high-value banknotes is expected to dent the
economy by sharply hitting consumer demand.
The RBI had last cut the repo rate in October, and analysts
had expected another cut by early 2017 after inflation has
continued to decline.
(Additional reporting by Manoj Rawal and Swati Bhat; Editing by
Kim Coghill and Eric Meijer)