The Reserve Bank of India’s draft circular on liquidity coverage ratio has met with resistance from several banks. The RBI circular proposes assigning an additional 5% run-off factor to retail deposits facilitated by internet and mobile banking services. According to the banks, this would require them to maintain a higher level of high-quality liquid assets to meet their LCR requirements. Moreover, these new guidelines could hinder loan growth, especially since banks are already facing challenges with deposit mobilisation.
These draft regulations come at a time when the increased use of internet and mobile banking has impacted deposit stability. The rise of digital banking has led to faster and more frequent withdrawals, contributing to a decline in stable savings deposits.
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The draft LCR circular
The liquidity coverage ratio measures how much high-quality liquid assets a bank holds to cover its short-term obligations, such as customer withdrawals. The LCR ensures that banks maintain a buffer of easily liquidated assets to meet potential withdrawal demands over a 30-day period. In simple terms, the new LCR circular asks banks to reserve more money for these types of deposits due to the challenges posed by the growing use of digital banking platforms, which have altered traditional deposit behaviours.
The draft regulations suggest that banks will need to apply additional risk weight to deposits made through internet and mobile banking (IMB). IMB covers services such as internet banking, mobile banking, and the Unified Payments Interface (UPI), enabling customers to transfer funds digitally. If these new norms are implemented, retail deposits with internet and mobile banking facilities will have a run-off factor of 10% for stable deposits and 15% for less stable deposits.
Bankers’ concerns
With more than 90% of retail deposits linked to internet and mobile banking facilities, the proposed LCR changes could significantly affect nearly all retail deposits. If implemented, banks may be less inclined to encourage customers to link their accounts to mobile and internet banking, according to industry insiders. This could slow down the pace of digitalisation.
While the Indian Banks’ Association is currently considering its response to the RBI’s draft guidelines, individual banks have already voiced concerns. The proposal comes at a time when banks are already struggling to secure more deposits, while loan growth continues to rise. For nearly two years, deposit growth has lagged behind loan growth. While the pace of credit offtake has also slowed, it is still outpacing deposit growth, forcing banks to rely more on alternative funding sources such as wholesale deposits to meet lending demands.
The RBI has also raised concerns about banks’ increasing reliance on short-term, non-retail deposits to bridge the gap between loan and deposit growth. This practice can pose liquidity risks to the banking system.
According to the latest data from ICRA, the share of deposits from retail customers and small businesses has decreased from its peak of 59.5% in June 2021 to 54.7% by March 2024. This decline is attributed to stronger growth in wholesale deposits. As wholesale deposits carry higher run-off factors, their increased share negatively impacts banks’ reported LCR. ICRA estimates that if the proposed norms are implemented, banks’ LCR could drop from 130% in Q4 of FY24 to around 113-116%.
ICRA also projects that non-food bank credit growth may slow to Rs 19-20.5 trillion (11.6-12.5% year-on-year) in FY25, compared to Rs 22.3 trillion (16.3%) in FY24, due to the proposed changes to the LCR. A slowdown in non-food bank credit growth could pose a risk to India’s economic growth.
The implementation of these norms will also require banks to allocate an additional Rs 5-6 lakh crore to government bonds. This change will take effect in the next financial year, giving banks time to adjust their operations and provide feedback. While the increased allocation to government bonds may affect banks’ margins and deposit costs, the actual impact will depend on their ability to effectively manage liquidity.
Banks have urged the RBI to ease the new norms, arguing that they will hurt margins and constrain funding to the corporate sector. The banking industry has suggested imposing an additional run-off factor of 2-2.25%, instead of the proposed 5% increase. Several banks have also recommended a phased increase over three years for maintaining liquid assets under the new LCR guidelines. They have requested similar adjustments for other deposit categories as well.
To mitigate potential LCR losses resulting from the proposed changes, banks may prioritise retail deposits, reduce their reliance on wholesale deposits, moderate credit growth, and allocate a larger share of deposits to high-quality liquid assets.
The growing prevalence of digital transactions could accelerate deposit withdrawals during times of economic stress, prompting the RBI to revise liquidity requirements. It is estimated that approximately 80% of total retail deposits could be affected by these changes, with Public Sector Undertakings (PSUs) potentially seeing a slightly lesser impact.
The RBI’s LCR draft presents a new challenge for the banking sector, as liquidity management and margin pressures remain a concern. The ultimate impact will depend on feedback from banks and potential revisions to the guidelines. The RBI’s own assessment of the proposed changes’ effect on the banking system and the broader economy is eagerly awaited.