At the morning meeting with bankers before announcing the January monetary policy, RBI governor Duvvuri Subbarao had a few simple, curt messages to the CEOs. Increase deposits and go slow on loans, or else be prepared to face the music. His concern stemmed from a number derived from FY11 9-month data submitted by banks. It said that incremental credit-deposit ratio of the banking industry was more than 100%. Simply put, it meant that banks gave more loans than deposits received during the period. As loans outstripped deposits, banks borrowed overnight and short-term money from RBI and money market to lend. It was a risk, Mr Subbarao felt, they should not be taking.
The central bank rarely spells out its concerns in too many words. But bank chiefs were quick to sense what's expected of them. RBI thinks that banks, largely to preserve their profits, have been slow in raising interest on deposits which reflects their cost of funds. As they dragged their feet, there was a growing mismatch in bank books which was not immediately visible to shareholders, many of whom felt that a lower fund cost meant great business sense. But the banking system was slowly exposing itself to a risk that disturbed Mr Subbarao. As banks kept interest rates low, savers moved money to other avenues like small savings where it gets locked for a long time. RBI has partly blamed banks for the liquidity crunch which is roughly measured by the amount that banks borrow daily from it; that number for many months has been around Rs 1 lakh crore. Money so borrowed was cheaper than deposits, but it was short-term money that went to fund longer duration loans. In the financial year to December, bank credit rose 16% while deposits moved up by 10%.
Time-tested Game
RBI deputy governor Subir Gokarn was forthright when ET reporters met him. "We have articulated our belief that this is not an individual bank's issue... the disparity across banks leads to some sense of risk of instability and ultimately, it's the question of how credit is being financed by overnight borrowing from the repo window. It's not sustainable," he said.
Indeed, banking, often jokingly said, is a congame that gives someone the licence to borrow 5-day money to give a 5-year loan. Such mismatches in balance-sheets are based on certain presumptions. First, all the money will not flow out of a bank on the same day; and second, customers will continue to deposit money with banks. While these are time-tested games that bankers play, tolerance among regulators has come down after the global financial meltdown.
Central bankers, traditionally a conservative tribe, shudder at the thought of a financial crisis and depositors queuing up to pull out money. Regulators in emerging markets made a mental note of the trauma that many advanced markets suffered after the Lehman collapse. When a customer steps into a bank to withdraw money, the teller is obliged to return the money; it doesn't matter if the deposit has a year to mature. But if a bank has made a commitment to give a loan, it can't go back. Besides, in a crisis, the second assumption does not work. In a panic, depositors sit on cash as high-street banks in the US and the UK realised as some of the nightmarish scenarios outlined in textbooks came alive.
What also worried RBI was the widening gap between the average tenure of loans and deposits. "On the one hand, the maturity of deposits has come down substantially - more than 70% of these are of around two years. But on the lending side, if you consider infrastructure, it needs financing for a longer term," pointed out Anand Sinha , deputy governor, RBI.
Widening Gap
A quick look at RBI data shows that more than one-third of bank loans mature over 5-10 years. After accounting for mandatory requirements like gilt investments and setting aside cash with RBI that banks have to fulfil, lenders are not left with enough term deposits to fund long-term loans. "A bulk of lending is infrastructure and home loans. While both segments are on a growth path, they require long-term loans. The concern is that depositors are parking money for a shorter tenure of less than two years while average maturity of infra and home loans is 5-10 years. Thus, if there is liquidity and credit risk crisis, there could be a case where a bank is not able to roll over deposits to fund loans," said Hemindra Hazari , head of research, at Karvy Stock Broking. "In an environment, when repo is at 6.5% - the rate at which banks borrow from RBI - and interest on CDs - certificate of deposits or short-term deposits - is close to 9.5%, it provides an attractive opportunity for banks to borrow from RBI and deploy it in CDs of other banks or give loans at 8-9%. This adds to the asset liability mismatch," he added.
This is particularly relevant in India where banks have to invest about a quarter of deposits in government securities and park 6% of deposits with RBI in cash. When CD ratio crosses 100% - i.e, when banks lend more money than they mobilise - keeping cash with RBI or buying gilts becomes an uphill task because these are carried out with resources collected as deposits. An analysis of 29 banks shows that half of them have more than 100% CD ratio. Moreover, a large part of deposits is current and saving account (or CASA) money which depositors can withdraw anytime. Lenders like SBI and HDFC Bank have half their total deposits as CASA. While CASA deposits enable banks to prune fund costs and push up net interest margin, it's not exactly a story to be excited about. Even in normal circumstances, such deposits can fly out of bank books. It's very different in the case of term deposits where there is some resistance among savers to withdraw prematurely unless there is a big panic.
WHAT'S NEXT?
RBI wants credit and deposit growth to be aligned. This will happen in the fourth quarter, not primarily because the regulator wants it, but because the dynamics of banking operations in Q4 are significantly different from the first three quarters. First, PSU banks, which have a market share of 70%, will strive to meet the 18-20% deposits growth and are most likely to succeed. Towards March-end, banks dress up books by attracting short-term bulk deposits. Most PSU banks have committed a deposit growth of 20-22% in the statement of intent (SOI) submitted to the finance ministry. Second, loan growth has slowed in the past few weeks. SBI chairman OP Bhatt recently confirmed that credit growth is not robust. "We may not be able to sustain 20% credit growth target. It could be 18% for the full year," said Mr Bhatt. "If we have to achieve credit, we have to disburse Rs 55,000 crore loan this quarter."
Also, the base effect will play a role. Bank credit saw a spurt of Rs 1.15 lakh crore in the past fortnight of 2009-10 - the highest fortnightly growth recorded that year. Last March, bankers went into an overdrive to windowdress their loan books to show a higher percentage rise over FY09 when credit growth was dismal. This year, it may be another story. Instead of loans, banks will try to prop up deposits.
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