News Analysis

Liquidity or capital: Which will prove a bigger challenge for banks in 2020?

Radhika Merwin, BL Research Bureau | Updated on April 03, 2020

It was only a month back that the YES Bank fiasco had unfolded. Yet, amid the pandemic and the lockdown, the episode may now find only vague mentions, as a bank that came so close to going belly up.

The reconstruction plan dished out by the Centre and the RBI may have allayed concerns for now, but it is still early days to assess whether the bailout plan did the trick. Importantly, did the backing by marquee names in the banking industry avert the exodus of deposits from YES Bank after the moratorium was lifted?

Only time will tell.

But the entire episode has unfortunately rubbed off on other private sector banks viewed as close rivals to YES Bank in the past. In a recent concall, the management of IndusInd Bank had stated that the bank saw a 10-11 per cent decline in deposits, with the chunk of the withdrawals coming from government related accounts.

RBL Bank, in a recent release, stated that there were some run-offs of deposits in the March quarter (under 8 per cent), the reduction essentially in bulk deposits from government entities/corporations.

The fact that government entities have pulled out deposits from private banks, on perceptible concerns over the safety of their funds (post the YES Bank crisis) is ironical indeed. But, more importantly, it now poses a grave challenge for certain private banks.

The liquidity conundrum

The chunk of a bank’s liabilities is funded by borrowed funds, essentially deposits. Hence, a bank relies heavily on large amounts of deposits for its lending activity.

Through most of last year, the overall credit-deposit (CD) ratio at the system level was about 75-78 per cent. This implies that banks were able to deploy ₹75-78 out of every ₹100 in deposits as loans. While this may seem healthy (given that 4 per cent of deposits were kept aside as CRR and 18.5-19.25 per cent as SLR), at the micro-level, the liquidity situation has been skewed.

For instance, private banks such as Kotak Mahindra Bank, IndusInd, Axis Bank, ICICI Bank and RBL Bank have been sporting a high credit deposit ratio of 80-90 per cent through most of last year, thanks to strong credit growth of 20-25 per cent.

IndusInd Bank saw its loan book grow 20-29 per cent over the past four quarters. For RBL Bank, too, credit growth was a strong 20-35 per cent. The fall in deposits can hence impact credit growth significantly for such players in the coming quarters (aside from the ongoing slowdown owing to Covid-19).

While the RBI’s measures to infuse liquidity, cut CRR and increase marginal standing facility can help banks tide over short-term liquidity issues, they are only stop-gap fixes. Over the long run, some of these banks face a tough task in rebuilding their deposit base by reducing dependency on wholesale deposits. Amid growing cash flow problems and negative depositor sentiment towards private sector banks, ramping up deposits — essentially the lifeline of a bank — could be a challenge.

Capital crunch

If many private sector banks are constrained by deposit flows, what is ailing their public sector counterparts? After all, the credit deposit ratio for most of the PSBs have been lower, at 70-75 per cent, with loan growth in low single-digits for the past several quarters. The backing of the government (their largest shareholder) has also mitigated depositor worries of a YES Bank-like situation.

But a heightened risk aversion (after the NPA crisis) to lending, scarce capital, weak governance structure and merger compulsions are big dampeners for PSBs.

The bad loan crisis that led to huge losses and erosion in the capital of PSBs over the past three or four years has impacted their credit growth significantly. With bankers fearing a backlash to their actions in later years, lending decisions have been slow and limited.

The loan growth for most PSBs has been muted at 4-7 per cent over the past few quarters, indicative of the their wariness towards lending. The extent of risk aversion has been so great that banks have been wary of parking money even in quality bonds and debt instruments. What else could explain the sharp spike in money market bond yields by over 200 bps recently (impacting liquid funds’ performance)? In March, banks had parked ₹3-lakh crore under reverse repo (lending to RBI) on a daily average basis, indicative of the excess liquidity with banks. Yet they did not wish to invest even in high quality bonds, fearing a rise in yields and treasury losses.

The RBI announcing targeted long-term repo (TLTRO), where banks have to deploy the funds in investment grade (BBB rated and above) bonds, but do not have mark-to-market these investments, could offer some comfort to the banks. But again, the extent of investment in such bonds or towards lending would depend on each bank’s capital position.

After all, having funds is one thing; deploying them would depend on the amount of risk a bank can take. Regulations around capital (capital adequacy norms) require banks to hold capital that is commensurate with the risk of its assets. Hence, even if PSBs are not constrained by liquidity/deposits, their weak capital base can impact lending decisions.

Tackling Covid-led turmoil

The ongoing turmoil owing to the pandemic outbreak and lockdown will impact credit growth sharply and lead to a rise in delinquencies in 2020. Private sector banks having higher exposure to unsecured loans and the SME segment are expected to bear the brunt this time, putting a strain on their otherwise comfortable capital base.

In the case of PSBs, aside from SBI (that now carries the burden of steering YES Bank through the crisis), the other larger banks are either bogged down by past mergers (BoB) or are busy setting the stage for the big consolidation (PNB, Union Bank, Indian Bank and Canara Bank). The mergers could not be more ill-timed. At a time when the onus on the banking system to channel funds to crisis hit sectors and businesses is immense, banks cannot be seen tackling integration issues and back office operations.

It may be recalled that the massive ₹2.7-lakh crore of recapitalisation by the Centre into PSBs over the past three fiscals was through recap bonds, where the Centre essentially borrowed from banks to pump capital back into them (converting deposits into capital). In the Budget this time, the Centre has not made any provision for recapitalisation for FY21.

But a sharp slowdown in credit growth, rise in delinquencies and weak earnings would require the Centre to review its recap plan. Pumping capital into mammoth institutions (after merger) will be no mean task in a year when the Centre has other battles to fight.

Published on April 03, 2020

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