RBI's draft LCR norms: Banks likely to see 4-11% impact on earnings

The Reserve Bank of India’s draft norms proposing an additional 5 per cent “run-off” for retail deposits in the liquidity coverage ratio (LCR) calculations threaten to slice bank earnings by 4-11 per cent as lenders will have to decelerate loan growth while taking measures to bolster sluggish deposit growth by offering higher interest rates, according to according to analysts.

Citing the increasing prevalence of mobile and internet banking in India, which enables depositors to easily withdraw their funds, the central bank has suggested an additional 5 per cent run-off factor for retail deposits with digital banking facilities. Analysts predict that the potential impact on LCRs, should these norms be enacted, could be as severe as a 20-30 percentage point reduction.

“Banks do carry buffers over LCR norms, but to maintain current levels, they may need to increase deposit growth/trim loan growth, which could affect earnings by 4-10 per cent, with a higher impact on PSU banks,” Jefferies said in a note to its clients.

According to analysts, banks with an LCR exceeding 130 per cent are relatively comfortable, though not many lenders boast such robust ratios.

“Banks will need an additional 4 per cent deposit growth to maintain the LCR, which is challenging and will be possible only with steep deposit rate hikes. Banks with LCR greater than 130 per cent (only a handful) are safe,” asserted broking firm Nuvama. It anticipates that the earnings impact on banks could range from 5-11 per cent, noting that SBI, ICICI, and HDFC Bank hold the largest share of retail LCR deposits. “We see this as highly negative because it will reduce LCRs by 20–30 per cent,” Nuvama added.

The immediate market reaction was seen with Federal Bank, which reported an LCR of 112.6 per cent as on June 30, 2024. The Aluva-based bank’s stock tumbled over 3 per cent on Friday, contrasting with a 1.6 per cent rise in benchmark indices.

Broking firm Macquarie said that the new norms could trim banks’ LCR by 16-20 percentage points, describing this as “large and worrisome”. Jeffries similarly estimated a 20-30 percentage point impact on LCRs.

“The issue is there is a fine balance between LDR (loan deposit ratio) and LCR that banks have to do and the tight liquidity conditions only complicates the matter,” stated Macquarie’s note.

In response to the impending regulations, banks on Friday responded by purchasing government securities, which are classified as high-quality liquid assets. This activity led to a softening of yields, with the benchmark bond yield settling at 6.94 per cent, down from 6.96 per cent on Thursday.

“Maybe a bit of over-exuberance is there in the market. (LCR rules are) still in draft mode, so maybe the market is still a bit ahead of itself,” remarked Naveen Singh, vice-president of ICICI Securities’ primary dealership.

The banking regulator’s proposal for a higher run-off factor follows the collapse of Silicon Valley Bank in the United States last year, which experienced a $42 billion run on deposits in a single day.

A report from IIFL Securities highlighted that banks have been rapidly consuming excess liquidity over the past year to satisfy strong credit demand. Consequently, the system-wide LCR has dropped by 12 percentage points to 135 per cent-5 per cent for private banks, and 15 per cent for public sector banks since March 2022. The report also noted that the RBI has not acceded to banks’ requests to include cash reserve ratio funds in the high-quality liquid assets (HQLA).

Current regulations require banks to maintain a 100 per cent liquidity coverage ratio. This means that their stock of high-quality liquid assets (HQLA) matches total net cash outflows. The LCR is designed to enhance the short-term resilience of banks to potential liquidity disruptions, ensuring they possess sufficient HQLAs to withstand a 30-day acute stress scenario.