The transition from a state of plenty of liquidity to stringent liquidity conditions is turning banks more risk conscious, impacting their business strategies. The continuing tempo of global rate hikes, tight liquidity conditions, sticky inflation, currency risks, volatile investment flows, haunting geopolitical risks, falling trade volumes, fear of recession flagged by leading global think-tanks, slowing economies and their interconnected risks are slowly exacerbating downside risks to the economy despite its innate resilience and policy interventions.
The average net durable liquidity injected into the banking system in April was ₹8.3 trillion which has now fallen to ₹3 trillion. Credit growth in banks as on October 21, 2022 was 17.9 per cent as against 6.8 per cent (year-on-year)recorded during previous year.
As against that, the deposit growth is still languishing at 9.5 per cent creating a huge gulf in resources. A jump in credit offtake is good for the economy but poses liquidity risks that can potentially disrupt the pace of growth if not tackled well in time.
The stiff fight for deposits is increasing term deposit rates close to 7-7.5 per cent providing some signs of positive real interest rates when inflation has begun to decline. As a result of rising term deposit rates, the share of current account savings accounts (CASA) deposits is falling that could increase cost of deposits. Banks have cut savings bank interest rates after they were deregulated.
Since the volume of CASA deposit base is strong, even a small reduction in interest rate on savings bank deposits could perk up profitability. When CASA was flowing seamlessly, strategy to lower its interest rate did work but with stiffening liquidity conditions, banks should consider raising interest rates on savings, particularly when term deposit rates are looking up. Otherwise funds from CASA would logically move into term deposit segment raising cost of resources — a trend that had already set in.
Liquidity position
In the financial markets, call rates are zooming past the reverse repo rate of 5.65 per cent. Banks are constrained to mobilise deposits through certificate of deposits (CDs) at as high as 7.97 per cent interest rates. The near-term CD rates are ruling high at 7.15 per cent for even 92 days indicating the paucity of funds.
As a result, the outstanding CDs have increased from ₹0.57 trillion a year ago to ₹2.41 trillion now. The total borrowings of banks increased from ₹2.74 trillion as on March 25, 2022 to ₹5.49 trillion on October 21, 2022.
In the given liquidity conditions, when the credit deposit (CD) ratio of banks is at 75 per cent given that SLR is at 18 per cent and CRR at 4.5 per cent, there is not much liquidity latitude left for banks unless the deposit mobilisation is aggressive.
Some banks having CD ratio close to 100 will face huge liquidity risks; those which were banking on easy money. They may have to fund the liquidity gaps at higher market driven interest rates thus susceptible to earnings at risk. Alternatively, they have to be aggressive in offering higher interest rates on term deposits to mop up funds.
Risk management strategies
Given the tight liquidity conditions, banks have begun to adopt stiffer risk management strategies to cope with liquidity risk. While RBI has assured liquidity but it may come at a cost when the benchmark Indian 10-year government bond yield ended at 7.27 on November 16.
With RBI sensitising banks towards evolving macroeconomic situation including global spill overs, banks should rework their liquidity and credit risk management strategies proactively. Even banks that are flush with funds are lending only to highly rated borrowers.
As a result, entrepreneurs may find it difficult to fund their investment plans unless they have a good and stable credit rating. It is notable that credit rating of borrowers cannot be earned quickly. They need to be built over a period of time with conscious credit discipline.
This is the opportune time for Secondary Loan Market Association (SLMA) formed by 10 leading banks in August 2020 to activate secondary sale of loans to rejig risk appetite and to ease the stress on liquidity risk management. Axis Bank has taken the lead to go live proposing to sell loans worth ₹1,000 crore recently through SLMA platform — a move that needs to be strengthened.
Way forward
In many ways, the present challenging risk environment should help institutionalise better credit risk underwriting methods. It can activate secondary sale of loan assets for better exposure management and help balance liquidity. It also underlines the importance of deposit accretion and customer relationship.
Going forward, banks can create distinct lines of business in credit risk management ecosystem to gain expertise in managing borrowers with different levels of credit rating tracks by ensuring a targeted risk adjusted return on aggregate basis.
Banks can factor floating risk adjusted pricing aligned to credit rating to achieve the targeted yield. Incentivising borrowers with better compliance and credit discipline can be a better value proposition instead of curbing lending to good entrepreneurs having weak credit rating. Handholding them with proper support is essential to help them improve their credit history.
Thus, the lessons in navigating through the current tough times should be integrating robust risk management and monitoring methods and infusing compatible risk management skill sets on a sustainable basis instead of taking ad hoc measures to deal with stressful times.
The writer is Adjunct Professor, Institute of Insurance and Risk Management. Views are personal