The last time the Reserve Bank of India (RBI) resorted to liquidity tightening tactics to shore up the rupee in 1998, the measures proved successful and were rolled back in two months. That does not seem to be the case this time around. If the central bank extends its latest measures beyond a couple of months, there will be collateral damage in the form of squeezed bank margins and lower earnings. That is reflected in the sharp 14% fall of the BSE Bankex compared with 4% for the broader market since mid-July.
The cash crunch will affect banks in many ways, though private banks seem more at risk. For one, capping the individual limit for banks to borrow at RBI’s Liquidity Adjustment Facility (LAF) window at 0.5% of their individual net demand and time liabilities will affect banks that maintain a tight liquidity situation—essentially new private banks. For instance, Kotak Mahindra Bank Ltd’s advances and investments are to the tune of 1.5 times its deposits, according to data from Espirito Santo Investment Bank. Similarly, Yes Bank Ltd’s investments plus credits and customer assets amount to 158% of its deposits.
Banks that depend on wholesale funding are the ones most in danger.
Three-month certificate of deposit (CD) rates have risen by 2.9 percentage points in the past three weeks while one-month CDs yield 1.5 percentage points more. According to data from Espirito Santo Investment Bank, new generation private banks have among the highest dependency on wholesale funding sources such as bulk deposits and CDs. If one totals CDs, bulk deposits and borrowings, Yes Bank depends on these sources for 69% of its funds and IndusInd Bank Ltd for 56%.
That’s not all. Some of these banks also have a significant amount of liabilities in the shorter-maturity categories. Thus, if rates hover at these levels for more than a quarter then the danger to bank earnings becomes more apparent. Yes Bank will have to renew/refinance 81% of its funds within a year compared with 68% for Kotak Mahindra Bank and 71% for ING Vysya Bank Ltd.
The last time these banks were exposed to this sort of sharp rise in funding costs was in fiscal 2009, in the aftermath of the North Atlantic financial crisis. However, Yes Bank was able to hold on to its margins at 2.8-3% and maintained a frenetic pace of profit growth. Despite some stutters in a couple of quarters, Kotak Mahindra Bank was able to do the same.
At the same time, note that Yes Bank’s Casa (current account and saving account) ratio has almost doubled to 20% in the past four years, while Kotak Mahindra Bank’s has improved by 6 percentage points to 37%. The latter has also pruned its growth guidance for this year, which will ease margin pressures to some extent.
Still, the comparison with fiscal 2009 may not be all that apt because the economic environment is more challenging now. Credit growth is slower and the outlook is getting gloomier by the day. Asset quality is much worse now and tighter liquidity will only exacerbate that condition. Thus, even the earnings of public sector banks that are sitting on a bigger pile of bad loans are at risk.