Short-term borrowings pose risk to banks: Crisil

Domestic banks' focus on short-term borrowings to fund long-term loans has led to an increased interest rate risk on their balance sheets, according to rating agency Crisil.

The percentage of long-term loans in the total loans and advances of banks has rised significantly to 45 per cent as on March 31, 2005 from the less-than 25 per cent reported on March 31, 1998.

In the same period, the percentage of short-term deposits grew by 39.4 per cent of total deposits from 27.7 per cent. This meant that banks were funding more of their long-term advances through short-term deposits, thereby widening the asset liability maturity (ALM) gap.

Besides, the rapid rise in home loan disbursements in the past couple of years has also worsened the ALM gap, banking analysts said.

Management of interest margins was the main reason for the banks to increasingly borrow short-term as the proportion of long-term loans in their portfolios increased with the growth in lending to the infrastructure and housing sectors.

"Given the hardening of interest rates, this strategy is risky as it has contributed to the increasing ALM mismatches. Considering the rising interest rate scenario, banks will have to revisit this strategy," the rating agency said.

The share of industry advances in gross bank credit, though declining in recent times, is continuing to be significant. As on March 31, 2005, it stood at 37.7 per cent of total credit.

Of this, share of infrastructure advances has steadily increased and as a percentage of banks' credit to the industry, infrastructure advances have grown to 15.5 per cent as on March 31, 2005 from a meagre 2 per cent on March 31, 1998.

Banks' total credit at the end of March 2005 was about Rs 15,00,000 crore and deposits at about Rs 21,00,000 crore. Short-term deposits and certificates of deposits (CDs) need to be rolled over every year.

This puts pressure on banks to raise resources for meeting redemption requirements, more so in a high credit growth environment.

If at that point of time liquidity in the market is tight then the cost of raising resources to meet redemptions increases. Further, the proportion of bulk deposits in short-term deposits has been steadily increasing over the past four years.

Bulk deposits are typically sensitive to the rising interest rate scenario and, therefore, volatile. More so since banks do not penalise such deposit holders for the premature withdrawals.

The focus on short-term borrowing has led to increasing the interest rate risk on banks' balance sheets. Crisil said an analysis of the interest rate sensitivity (IRS) statement of selected banks revealed that the duration gap had widened from 0.83 years as on March 31, 2004, to 0.97 years as on March 31, 2005.

When translated into the long-term impact on capital, this amounts to 24.7 per cent drop in value in case of a 200 basis points interest rate shock.