The Reserve Bank of India (RBI) has been repeatedly raising alarm about the widening gap between non-food credit growth and deposit growth in the banking sector, which raised the credit-deposit (CD) ratio to over 80% in the last week of March 2024 – the highest since 2005. In the year ended March 2024, deposits grew at 13.5% , compared to credit growth at 16%. The current CD ratio is a little below 80%, though for Small Finance Banks , the CD ratio is over 90%. How Indian banks finance their asset growth is crucial and the RBI Governor said recently “ Banks are taking greater recourse to short-term non-retail deposits and other instruments of liability to meet the incremental credit demand. This, as I emphasised elsewhere, may potentially expose the banking system to structural liquidity issues” What is the underlying risk of credit exceeding deposits? The risk is that while loans create deposits in accounting terms, the composition of deposits may create an asset-liability mismatch.
When people invest in mutual funds or insurance products, deposits do not leave the banking system, but return in the form of current accounts or short-term FDs. Banks can invest them in short term assets only and engaging in a long term asset against these is highly risky. Analysts rule out Liquidity Risk by the Liquidity Coverage Ratio (Liquid Assets/Liquid Liabilities) of 130% for Indian Banks. A Bank can meet LCR by having a large proportion of Liquid Assets such as Government Securities, which has interest rate risk, as there are repeated calls for rate cuts in an environment where food inflation is the major factor behind price rise. LCR could also be met by having a large proportion of liquid loans such as personal loans or credit cards , which has credit risk of its own. The ideal solution is Long Term Deposits be used against Long Term Loans. What are the best way to mobilise Long Term Deposits? They could be : (a) Treating Bank Deposits on the same footing as Alternate Investments. Tap the Infrastructure Bond Market which is free from SLR and CRR requirements (b) Focus on HNIs and Ultra HNIs for Long Term Deposits at customised interest rates. Affluent Customers can not only give higher value deposits but also a high fee-based income for Wealth Management Services (c) Focus on selling higher and higher Mutual Funds and Insurance products of Group companies for increasing Fee Based Income which can be lent forward without worrying about Liability behind the Assets.
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