RBI's new liquidity coverage guidelines for banks could slow credit growth

Mumbai: The Reserve Bank of India's latest guidelines asking banks to set aside a higher stock of liquid assets to meet a contingency like a potential bank run—a sudden spike in demand for withdrawals—could hit banks hard, hurting credit growth

In a draft circular released on Thursday, the RBI has asked banks to account for the possibility of an outflow of retail deposits through digital means, while calculating the liquidity coverage ratio (LCR). Currently, banks are required to maintain an LCR of 100%.

LCR norms require banks to maintain a stock of high-quality liquid assets (HQLA), primarily government securities, to tide over a hypothetical 30-day stress scenario in which deposit outflows occur.

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The guidelines mandate banks to keep a higher liquidity for deposits made through digital channels, as they aren't very stable and tend to be withdrawn quickly.

It has asked banks to assign a higher run-off factor of 10% on retail deposits made via Internet and Mobile banking (IMB), from the current 5%. Typically, the run-off factor on retail deposits is lower as these are considered stable.

Run-offs happen when individuals or businesses withdraw their deposits, which are not anticipated by banks. Stable retail deposits enabled with internet and mobile banking facilities will have a 10% run-off factor, and less stable deposits will have a 15% run-off factor.

Additionally, RBI has also asked banks to apply relevant haircuts on the assets, while calculating the LCR.

Bankers view the latest RBI move to be conservative, as it would force banks to invest more in government securities and go slow on credit growth. Also, considering that system liquidity is tight and deposit mobilisation is already slow, the impact on banks will be pretty big as they will be forced to both keep deposit rates elevated and temper some amount of growth to align with funding.

According to brokerage IIFL Securities, banks have been consuming excess liquidity over the last year to meet the strong credit demand, and system LCR has declined 12 percentage points to 135% .

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“It’s too early, we’re still doing our assessment. But I think the most important part is the 5% impact on clients who have transaction accounts which are eligible for internet as well as mobile banking. We have to see how the impact will be. This quarter, we’re at 122% and we’re very comfortable. Even if there is an impact, the rough estimate is it will be 4-5%. And we will see how to work it out, we have time till April,” said Sumant Kathpalia, MD and CEO, IndusInd Bank.

RBI's move is aimed at keeping banks prepared for any sudden withdrawal of funds by clients using digital channels, similar to US-based Silicon Valley Bank that collapsed last year after a bank run. Analysts believe that the draft guidelines, if implemented, will have an impact on banks' LCR.

"This in effect will reduce the banks' LCR by 8-11% assuming 50% of deposits (including rural) are linked to IMB and 12-19% assuming 90% are linked to IMB for large PVBs. The impact would be moderate for select mid-cap banks and PSBs," said Madhavi Arora, chief economist, Emkay Global Research.

According to Suresh Ganapathy, managing director and head of financial services research at Macquarie Capital, “If we assume 70% of the deposits meet these criteria and there is a 2% haircut to HQLA, the impact for our coverage universe on LCR would be around 16-20% which is large and worrisome. Many private sector banks have an internal threshold of 110% and LCR would drop below the threshold levels.”

According to IIFL Securities, the LCR guidelines will push banks to focus back on branch banking, while forcing them to mobilise more non-callable deposits and increase the share of High-Quality Liquidity Assets by keeping more liquidity on balance sheet.

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“Higher LCR requirements may have some bearing on credit/deposit growth and to offset the cost of carrying additional liquidity, banks have to keep the lending rates relatively higher and thus protect margins,” it said.

IIFL Securities' calculations show that among all the lenders, Federal Bank will see the sharpest fall in LCR from 113% to 95%, followed by IndusInd bank from 118% to 107%. HDFC Bank's LCR will fall from 123% to 109% and ICICI Bank from 121% to 108%.

While these are draft guidelines, the new rules will be applicable from 1 April 2025.