Indian banks are lending more than what they get as deposits — this is what was Reserve Bank of India (RBI) Governor Duvvuri Subbarao’s concern during the third quarterly review of the monetary policy.
The governor said the incremental credit-deposit (C/D) ratio of the banking sector was 102 per cent at the end of December 2010, up from 58 per cent in the corresponding period of the previous year.
Incremental C/D ratio indicates how much a bank has lent for every additional rupee it has received as deposit.
Ideally, banks cannot lend, for example, more than Rs 70 for every Rs 100 they mobilised as deposits, because they need to set aside Rs 30 in the form of cash reserve ratio (CRR) and statutory liquidity ratio (SLR). But, RBI says, for every additional Rs 100 deposit, banks are lending Rs 102, even after meeting CRR and SLR obligations!
How is that possible? Banks borrow in the overnight market, that is, call money market and from the liquidity adjustment facility of RBI, and lend it. Funds borrowed from the overnight market are required for product need, that is, to meet shortfall in CRR/SLR, and not for lending purpose. (Click here for graph)
Apart from deposits, banks can also use their borrowed funds for lending. However, RBI data show, Indian banks rely heavily on deposits rather than borrowed funds. Deposits constituted around 78 per cent of the total liabilities of banks in 2009-10, while borrowing formed only 8.7 per cent of the total.
If the trend continues, it can lead to widening of the asset-liability gap, which is the last thing a regulator wants.
“The incremental credit-deposit ratio has been above 100 per cent for the system and, therefore, RBI has rightly said banks should manage their resources portfolio to sustain credit deployment. Otherwise, it could lead to a huge mismatch between resources and credit,” said Bank of Baroda Chairman and Managing Director M D Mallya.
The situation is grave because most banks, especially the bigger ones, have high incremental C/D ratio. “Everybody is at the optimum position and the ability to provide cash support to each other when liquidity dries up is limited. This may lead to a systemic problem,” said an executive of a public sector bank.
High incremental credit-deposit ratio was mainly on account of low deposit growth, compared to credit growth. Deposit mobilisation was sluggish on account of very low return offered on term deposits that prevailed during most part of the year, as banks started raising deposit rates only after October.
Credit growth was over 23 per cent in the last one year and deposit growth around 16 per cent. At the beginning of the financial year, RBI had projected credit and deposit growth at 20 per cent and 18 per cent, respectively. It still maintains the projection and wants banks to cut down credit expansion.
Analysts said banks would cut down credit expansion during the fourth quarter. India Infoline Analyst Aalok Shah says: “While markets have factored in the higher C/D ratio due to increase in lending, in the fourth quarter, banks will have to go slow on their credit growth plans. RBI now wants banks to mobilise deposits, as some banks have not focused on it so far.”
In the Trends and Progress report on banking, RBI observed that asset-liability mismatch was noticeable for public sector banks with a shift in their deposit liabilities towards short-term end of the maturity spectrum, while loans and investments towards long term, during 2009-10.
Mallya suggests there is a need to focus more on resources and ensure it matches deployment. “Raising interest rates is not the only option. Banks can raise long-term funds, through, for example, Tier-II bonds. Sufficient cash should be there for credit deployment,” he said.
High inflation
During the peak of the liquidity crisis of 2008, RBI had reduced CRR aggressively to infuse funds into the system. The present cash crunch, which started in October 2010, prompted several measures by RBI, including leeway on SLR maintenance and making available the second liquidity adjustment facility. Both the measures, which was termed temporary, continue till date. RBI also conducted buyback of government bonds through open-market operations in December-January and infused around Rs 37,000 crore into the system, enabling banks to meet their credit requirement, though at the risk of stoking inflation.
If another liquidity crunch breaks out, the lender of last resort may not able to provide a helping hand.
“It will be difficult for the central bank to infuse liquidity, as inflation is high. A cut in CRR, as done in 2008, will not be contemplated as that send a wrong signal regarding the central bank’s view on inflation,” said a senior executive of a public sector bank.
