MUMBAI: The proposed higher mark-ups that the Reserve Bank is seeking from banks in the draft liquidity coverage ratio (LCR) framework will impact the LCRs by 10-30 percentage points (pps), thus reducing the cushion now available with banks over the regulatory requirement of 100 percent such ratio. In an analysis of 31 banks, Crisil ratings shows aid the near-term impact on credit growth and net interest margins is the price for enhancing resilience.
The Central Bank issued the new draft LCR guidelines on July 25 which it wants to be effective from April next. The draft guidelines propose to introduce three key changes to the LCR calculation. First, assigning an additional 5 percent run-off factor on the internet and mobile banking (IMB)-enabled retail deposits and certain small business deposits.
Secondly, it wants to restrict the value of government securities (G-secs) forming a part of level 1 high-quality liquid assets (HQLAs) to the market value, adjusted for applicable haircuts, in line with the margin requirements under the liquidity adjustments facility and the marginal standing facility.
Thirdly, it wants to treat deposits contractually pledged as collateral to a bank as callable, and hence included in the LCR math. These measures, the regulator believes, can enhance the resilience of banks against sudden and unanticipated deposit outflows.
“While the implementation of the circular in its current form will result in a reduction in the current reported LCRs given the higher stress factors proposed, banks will work toward re-building that corpus. But in the near-term they will have to bear slower credit growth and crimped net interest margins to the tune of 10-30 bps as they shore up liquidity buffers to manage the transition,” says the report.
The agency has analysed the impact of the proposed guidelines on 31 public sector and private banks which control over 90 percent of the systemwide assets, and the report is based on the presumption that around 75 percent of the retail deposits are IMB-enabled.
According to Ajit Velonie, a senior director with the agency, given the rising penetration of digital banking, the risk of sudden, large withdrawals during stress is higher now compared to the past, thus putting pressure on liquidity and the whole world has seen some instances of this last year in the US and Europe.
The proposed RBI guidelines aim to increase the buffer to enable banks tackle such emerging risks and the proposed revision will have an impact on the current reported LCRs of many banks.
The median LCR of the banks analysed stands at 136 percent as of end March 2024, and this will drop to 117 percent if the guideline is implemented as proposed, he said, adding, 17 of these 31 banks would have an LCR of under 120 percent, compared to the just three currently and of these 17, nine will have it under-110 percent as against none now.
The RBI move comes at a time when banks are grappling with deposits growing slower than credit. While the gap has narrowed to around 300 bps last fiscal compared to 600 bps in fiscal 2023, the initial months of the current fiscal have seen the difference widening again to around 400 bps. Many banks have been managing their funding requirements by dipping into their excess statutory liquidity ratio (SLR) holdings, among other avenues.
The LCRs of many banks have already been impacted by a reduction of over 250 bps in excess SLR, a key component of HQLA, between fiscals 2023 and 2024.
According to Subha Sri Narayanan, a director with the agency, “banks will need to strike a fine balance between growth and profitability. While not all banks may choose to restore their LCRs to original levels, they will still need to rebuild their buffers, resulting in a two-fold impact.
First, with greater investment in Gsecs to shore up the HQLA, resources available for lending will get curtailed, and to that extent, credit growth may moderate from our projection of 14 percent this fiscal.
Secondly, the higher proportion of lower-yielding G-secs in the asset mix, along with continued battle for deposits and a potential increase in deposit costs, can weigh on margins and profitability of banks.