Long-term liability key to improve funding gap in India's banking system---ET
Structural imbalances in the Indian banking system's funding structure are diluting monetary policy transmission, crowding out corporates from money market and discouraging long-term savings in the economy.
Banks' growing dependence on short-term deposits to fund an increasing share of long-term infrastructure and residential mortgage loans has built refinancing pressures for them, making it difficult to bring down the cost of deposits.
While repo rates reduced 100 bps between April 2012 and March 2013, the cost of deposits of the four largest government banks actually increased during this period. This divergence between deposit costs and the policy rate severely limits banks' ability to reduce lending rates.
In contrast, banks with matched funding profiles have better managed their cost of deposits. Transmission in FY14 would likely be equally tepid as in FY13, with monetary easing staying ahead of banks' ability to reduce deposit costs.
Funding gaps are unlikely to come off significantly unless the banking system issues long-term liabilities. Till then, banks may be unwilling to take a hit on NIM by reducing lending rates ahead of deposit costs.
Dependence on certificates of deposits (CDs) has grown steadily and the Indian banking system has converted from being a net lender in the money market till 2005 to being a net borrower.
The growth in CDs crowds out corporates, which see a drop in commercial paper (CP) volumes every time banks step up CD issuances. The effect was particularly visible in March 2013 when high CD issuances by banks led to a fall in outstanding CP, thereby exposing the limited ability of the domestic money market to fully accommodate the shift in banks' liabilities to the short-term.
The dominant share of short-term issuances compared with long-term bonds has affected the slope of the domestic bond market yield curve, which has been persistently flat-to-inverted throughout FY12 and FY13. This phenomenon is no longer a year-end feature but spread throughout the year, mostly on account of the continuous short-term refinancing need of banks.
Such a persistently flat yield curve can dissuade long-term savings and can be a setback for the Indian economy, which is looking to channelise longterm funds into the infrastructure sector for sustainable GDP growth.
Banks have been trying to reduce structural imbalance by encouraging long-term deposits; however, their availability is limited to large banks. For example, the five largest banks accounted for an estimated 51% of long-term liabilities (tenure greater than five years) in the system and the top 10 banks accounted for 81% in FY12.
Mismatches in loan and deposit tenures have resulted in rising funding gaps in banks' asset liability statements. For example, the cumulative one-year mismatch for government banks was 17.5% of assets at end of March 2012, significantly higher than the past.
Banks' growing dependence on short-term deposits to fund an increasing share of long-term infrastructure and residential mortgage loans has built refinancing pressures for them, making it difficult to bring down the cost of deposits.
While repo rates reduced 100 bps between April 2012 and March 2013, the cost of deposits of the four largest government banks actually increased during this period. This divergence between deposit costs and the policy rate severely limits banks' ability to reduce lending rates.
In contrast, banks with matched funding profiles have better managed their cost of deposits. Transmission in FY14 would likely be equally tepid as in FY13, with monetary easing staying ahead of banks' ability to reduce deposit costs.
Funding gaps are unlikely to come off significantly unless the banking system issues long-term liabilities. Till then, banks may be unwilling to take a hit on NIM by reducing lending rates ahead of deposit costs.
Dependence on certificates of deposits (CDs) has grown steadily and the Indian banking system has converted from being a net lender in the money market till 2005 to being a net borrower.
The growth in CDs crowds out corporates, which see a drop in commercial paper (CP) volumes every time banks step up CD issuances. The effect was particularly visible in March 2013 when high CD issuances by banks led to a fall in outstanding CP, thereby exposing the limited ability of the domestic money market to fully accommodate the shift in banks' liabilities to the short-term.
The dominant share of short-term issuances compared with long-term bonds has affected the slope of the domestic bond market yield curve, which has been persistently flat-to-inverted throughout FY12 and FY13. This phenomenon is no longer a year-end feature but spread throughout the year, mostly on account of the continuous short-term refinancing need of banks.
Such a persistently flat yield curve can dissuade long-term savings and can be a setback for the Indian economy, which is looking to channelise longterm funds into the infrastructure sector for sustainable GDP growth.
Banks have been trying to reduce structural imbalance by encouraging long-term deposits; however, their availability is limited to large banks. For example, the five largest banks accounted for an estimated 51% of long-term liabilities (tenure greater than five years) in the system and the top 10 banks accounted for 81% in FY12.
Mismatches in loan and deposit tenures have resulted in rising funding gaps in banks' asset liability statements. For example, the cumulative one-year mismatch for government banks was 17.5% of assets at end of March 2012, significantly higher than the past.
Results for FY13 suggest that the rise in gaps may have been arrested through banks focusing on raising long-term deposits; however, the sustainability of any improvement may be tested by the insufficient availability of term deposits.
Funding gaps in some banks are higher than the stock of government securities and cash on the balance sheet, indicating a shortage of ready collateral for repo deals with RBI in the event of a systemic liquidity crunch.
While the refinancing ability of government banks in normal conditions has never been in doubt, the large gaps suggest a high level of dependence on short-term money market borrowings and vulnerability to elevated deposit costs due to refinancing pressures.
Banks' dependence on short-term liabilities is also reflected in the high proportion of deposits maturing in less than six months. Although short-term liabilities (maturing in less than six months) constituted 31% of total deposits for the banking system and is not an alarming number by itself, it needs to be seen in the context of a lengthening loan portfolio.
The ratio was greater than 40% for seven banks in Ind-Ra's universe of rated banks. The current imbalance in the banking system's liability structure needs to be rebalanced for borrowers to benefit from falling interest rates.
The level of dependence on short-term deposits is now arguably unsustainable, and the share of long-term loans such as infrastructure and mortgages may not decline. A sustainable source of long-term liabilities is, therefore, needed to match the growth in long-term infrastructure and residential mortgage loans.
Funding gaps in some banks are higher than the stock of government securities and cash on the balance sheet, indicating a shortage of ready collateral for repo deals with RBI in the event of a systemic liquidity crunch.
While the refinancing ability of government banks in normal conditions has never been in doubt, the large gaps suggest a high level of dependence on short-term money market borrowings and vulnerability to elevated deposit costs due to refinancing pressures.
Banks' dependence on short-term liabilities is also reflected in the high proportion of deposits maturing in less than six months. Although short-term liabilities (maturing in less than six months) constituted 31% of total deposits for the banking system and is not an alarming number by itself, it needs to be seen in the context of a lengthening loan portfolio.
The ratio was greater than 40% for seven banks in Ind-Ra's universe of rated banks. The current imbalance in the banking system's liability structure needs to be rebalanced for borrowers to benefit from falling interest rates.
The level of dependence on short-term deposits is now arguably unsustainable, and the share of long-term loans such as infrastructure and mortgages may not decline. A sustainable source of long-term liabilities is, therefore, needed to match the growth in long-term infrastructure and residential mortgage loans.
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