A large Indian commercial bank borrowed Rs1,000 crore from another major domestic bank at more than 20% interest rate earlier this week, a desperate move that underscores the gravity of the liquidity scarcity for some Indian banks, notwithstanding assurances to the contrary by regulators and politicians alike.
The short-term money was raised through certificates of deposits, or CDs, essentially a promissory note that bears a maturity date and a specified fixed interest rate.
It appears that this is the highest interest rate charged by any Indian bank on a 45-day loan given to another bank since the mid-1990s, when liquidity was scarce and interest rates soared, following a tight monetary policy by the central bank against what was then a backdrop of rising inflation.
This time around, the root of the problem is global liquidity crunch and banks’ sudden and growing aversion to lend to each other as the general confidence level in the banking system has declined sharply in the past one month.
Banker’s Trust is unable to name the banks involved because that was a precondition to confirming details of this sensitive transaction.
While the structural stability of the Indian banking system hasn’t come in question in the global meltdown that has already taken down several banks, even Indian banks that can afford to lend now don’t want be stuck just in case there is another bank collapse and would rather keep as much cash as possible in case they, too, have to deal with any large withdrawals by depositors, especially companies and funds.
In this particular case, the borrower of the money was desperately looking for funds to tide over short-term asset-liability mismatches in its overseas operations. Most of the large Indian banks, both state-run as well as private ones, have overseas presence. The aggressive ones have been building assets overseas by rolling over their liabilities, raised from the inter-bank market.
But these money lines are now fast drying up and it is difficult to replenish them as overseas banks are not rolling over the credit any more even though the London interbank offered rate, or Libor, an international benchmark for interest rate, is soaring. Libor is now much higher than the yield on three-month US treasury bill, and this illustrates the risk perception of financial institutions about each other. If they have money, they would lend to the US government and not to a fellow institution.
So, if an Indian bank faces a liquidity crunch abroad, it is now being forced to borrow from India, convert the money into foreign currency, and then quickly export the funds to support the bank’s overseas operations.
Despite the gravity of the situation, the good news is that this transaction shows how, unlike their counterparts in the US and the UK, Indian banks can still find money within their ranks with bank chieftains still able to seek and get large favours from peers as they look to tide over a crisis that has only grown in magnitude despite concerted actions by many global banks as well as steps by the Reserve Bank of India, or RBI.
Still, the fact is that Indian banks, including the ones in this case that are large and more than adequately capitalized, are simply not insulated from the global banking and stock market problems. As a result, as this saga illustrates, some banks are willing to borrow at any rate as they cannot afford to default in redeeming liabilities at this critical juncture.
What is perhaps more problematic is that this funding need may not remain unique to Indian banks with overseas presence.
Indian bankers privately concede that they have started finding it difficult to raise funds in their domestic operations, too, and at least a few of them have almost stopped giving out any loans.
Several Indian banks are not sanctioning fresh loans and going slow in disbursing loans already committed even as major corporations are knocking at their doors, fearing a looming shortage of funds.
Typically, at the beginning of the fiscal year, banks fix a limit for the so-called working capital, or cash credit, for Indian firms to fund day-to-day activities, such as buying raw materials and building inventories. Most firms normally don’t use the entire credit facility.
But, in the past few weeks, many Indian firms have wanted to draw down their entire cash credit limit from their banks as they apprehend a more dire cash crunch in coming weeks and months.
As a result, many banks are also not in a position to oblige many of their corporate clients.
The cost of a one-year deposit has gone up from around 9% to as much as 10.5-11% in the past few weeks and for wholesale deposits, the cost is now not less than 12%.
“Once I load the cost of SLR and CRR on this, the cost increases. On top of this, when I add the risk premium, I can’t lend below my prime rate unless I want to pay from my own pocket,” says Allen C.A. Pereira, chairman and managing director of Pune-based Bank of Maharashtra.
The prime lending rate, or the rate at which public sector banks are supposed to lend to their prime borrowers, varies between 13.75% and 14%, but, until recently, 80% of the loans were offered below the prime rate.
Union Bank of India’s chairman M.V. Nair says he has stopped “marketing for new loans”. India’s largest lender, State Bank of India, too is showing caution in lending to corporations amid a growing desire to stretch out existing cash balances as much as possible in case the future liquidity scenario worsens.
By law, Indian banks cannot use their entire deposit portfolio to lend. They need to keep 9% of their deposits (8.5% from 11 October, following half a percentage point cut) with RBI as cash reserve (defined by the cash reserve ratio, or CRR) on which they do not earn any interest. Besides, they also need to invest 25% of their deposits in government bonds to meet the statutory liquidity ratio, or SLR (RBI recently brought this down to 24% to offer temporary relief to the banks).
In other words, for every Rs100 in deposits with them, Indian banks can only lend Rs67.50.
But, according to RBI data, banks’ credit-deposit ratio in the second week of September was 73.16%. This means, for every Rs100 of deposits, they are already using Rs73.16 for lending, instead of what was technically the limit, Rs67.50. This extra lending was mostly coming from their capital and reserves, as well as borrowing from other banks.
So, if Indian banks now stop lending to each other, the problem will sharply magnify.
Bank chieftains insist that they are still not too averse to lend to each other because they believe in the stability of the overall system, but privately say they will only do so if there is an opportunity to have huge returns for the risk—north of 20% for short-term lending.
Meanwhile, the volume in the overnight call money market, where banks borrow and lend to take care of their temporary asset-liability mismatches, is already coming down.
The same goes for collateralized borrowing and lending obligations, or CBLO, run by Clearing Corp. of India Ltd, where non-banking entities, including mutual funds, insurance firms and provident and pension funds, can participate.
The maturity of such loans varies normally between one and 90 days. On 8 October, the CBLO volume was Rs12,532 crore, already down 79% from the highest volume that this market recorded on 8 March, which was Rs59,784 crore.
Indeed, bank CEOs, such as M.D. Mallya, chairman of Bank of Baroda, and B. Sambamurthy, head of Corporation Bank, say liquidity has to improve, quickly.
RBI’s recent half a percentage point cut in CRR, which will release Rs20,000 crore into the system, is unlikely to help much as 50% of that will be drained out through floatation of government bonds.
Besides, RBI’s support to the local currency also drains liquidity as for every dollar the central bank sells in the market to stem the fall of the Indian unit, an equivalent value of rupee is sucked out from the financial system.
Finance minister P. Chidambaram’s statement that he is conscious of the fact that the liquidity conditions have tightened and “steps will be taken to infuse more liquidity, if needed” somewhat stemmed the fall of the stock market on Wednesday as they went into Thursday’s holiday.
But, the banking regulator will need to walk the finance minister’s talk to keep a relatively sound Indian banking system from running into trouble.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Send your comments on this column to email@example.com.