Banks should proactively manage the pricing and duration of their deposits while trying to diversify the sources and avoid over reliance on bulk deposits, Reserve Bank of India (RBI) Deputy Governor Swaminathan J said on Thursday.

“Excessive reliance on bulk deposits should be avoided as these are more sensitive to interest rate movements and perpetuate concentration risk while also eroding earnings,” he said at SBI’s Banking and Economic Conclave.

During the pandemic, banks saw a surge in retail deposits resulting in CASA deposit ratios touching a peak of up to 60 per cent. However, with normalisation in retail deposits since then, banks have started relying more on bulk deposits for the last few quarters, resulting in CASA ratios moderating to 40-50 per cent and expected to fall further in the coming months.

When the interest rate cycle reverses, external benchmark-linked loans will be repriced much faster than deposits that contracted during the peak of the interest rate cycle resulting in pressure on NIMs (net interest margins) and eventually profitability, Swaminathan said.

“Increasing NIMs that banks are presently enjoying may not be sustained in the future when the interest rate cycle reverses,” he said, adding that therefore banks must be mindful of not just the interest rate risk in their trading book, but also in the banking book.

While recent regulatory changes such as the symmetrical treatment of fair value gains and losses as well as removing restriction on HTM (held-to-maturity) have given banks greater flexibility in managing their investment portfolio risk, the dynamic nature of the interest rate risk means that banks must proactively manage and mitigate this risk, he added.

The central bank cut the policy repo rate from 5.15 per cent to 4.0 per cent between March and May 2020 owing to Covid-led disruptions. The rate remained at that level for two years before being increased to 6.50 per cent between May 2022 and February 2023.

As such, banks today are in a much better place compared with five years ago. As of September 2023, banks’ Capital to Risk Weighted Assets Ratio “stood impressively” at 16.79 per cent, underscoring the sector’s resilience. Gross NPA ratio of banks was at a decadal low of 3.25 per cent and the net NPA ratio was at 0.76 per cent. Further, the uptrend in profitability has continued for the fourth consecutive year, with Return on Assets (RoA) at a healthy 1.3 per cent and Return on Equity (RoE) at 12.5 per cent.

“As we note the current state of our financial system, it is also imperative to reaffirm our commitment to maintaining and building upon this robust position. Our journey towards resilience should not end with achieving impressive metrics; it requires a continuous dedication to sound financial practices, prudent risk management, transparency and ethics,” Swaminathan said, adding that it is crucial to ensure financial institutions remain resilient in the face of any future challenges.

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