This minimum requirement will be phased up to 100% by March 2019, with an increase of 10% every financial year. While most banks are comfortably placed, some names from the public and private sectors barely met the regulatory requirements in March 2015.
LCR Transition to 100% Likely to Impact Profitability: Banks will need to bring their LCR ratios above 100% by March 2019. This could be achieved by either reducing outflows from the liability side by garnering more stable deposits (such as those from retail and SME clients and any non-callable deposits, which have lower runoff rates) or increasing the asset side HQLA component (cash in hand, excess cash reserve ratio (CRR) and excess statutory liquidity ratio (SLR) securities) which comes with its own drag on margins. However, improvements on the liability side may take time to materialise depending upon the pace of retail deposit accretion. Banks that have been losing retail deposit market share over the last few years or the ones running high asset-liability management (ALM) mismatches in the short-term buckets would be compelled to keep a high proportion of HQLA to manage their LCRs. This would necessarily be a drag on their profitability owing to low yielding SLR securities replacing high yielding advances.
HQLA Requirements Would Further Drag Credit Growth: The median amount of HQLA to total assets ratio and NCOF to total assets ratio for the banking system stood at 10% as of March 2015. The HQLA component comprises primarily excess SLR and CRR requirements for banks, along with the securities allowed under the marginal standing facility (at a maximum of 2% of net demand and time liabilities (NDTL)) and the facility to avail liquidity for LCR (a maximum of 5% of NDTL). These measures make up 90%-95% of the reported HQLA number in most banks.
If RBI does not increase the facility to avail liquidity for LCR from the current level of 5%, banks will need to increase their excess SLR or CRR to shore up their LCRs. This could hamper funds that were previously available for credit growth, reducing banks' profitability. Banks with below 100% LCR would need, on average, to increase HQLA to the tune of 4% of the total FY15 assets or 4.5% of NDTL. This ranges as high as 8% for some banks and would imply that some banks would need to raise SLR levels to above 30%. This would imply a return on assets impact of 6-8bp till FY19.
NCOF Heavily Dependent on Depositor Profile & Asset Tenor: Banks with high NCOF will need to contain their wholesale deposits and will need to incentivise retail and SME deposits. One recently opened route to do so would be by incentivising non-callable deposits for customers, which is likely to come at a higher cost and consequently would impact net interest margins.
The other way to reduce NCOF would be by increasing inflows in a 30-day period. Inflows for certain banks may be low due to their exposure to long tenure assets such as infrastructure loans. These banks may need to take exposure to short-term assets by reducing loan or investment tenors. This indicates a need to increase the mix of money market instruments or working capital loans.
LCR and Structural Volatility Issues: The reported LCR numbers have been quite volatile, and monthly averages have shown significant variance up to 1HFY16. Comparing the residual maturity based NCOF on a 30-day basis (as reported in structural liquidity statements) against the weighted values of the same (as used in the LCR calculation) shows the extent of the differences between the two measures, with some banks effectively managing their LCR ratios and some struggling with it.
Depositor Classification May be the Differentiator: While NCOF factors in the behavioural maturity of assets and liabilities, the annual disclosure only considers the residual maturity. A comparison between these within a 30-day bucket indicates that many of the banks reporting lower LCR ratios may benefit from re-examining their classification of these deposits as stable and less stable. Promoting classification of deposits as non-callable or incentivising stable deposits will allow for the NCOF to reduce, shoring up LCR.
LCR Poses Cash Management Challenges: Ind-Ra expects the structural volatility in LCR to increase, given the proposed switch from monthly to daily average LCR calculations by March 2017. This transition will impact daily cash management for banks, as they would have to adjust their HQLA components accordingly, restricting available funds on an everyday basis.
Most banks managed to shore up their LCR ratios in 1HFY16, primarily by increasing their HQLA covers and taking some profitability hit. However, improving the liability profile through the transition would be critical for cushioning the impact on return on assets.
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