At 5.4 per cent repo rate after Friday’s 50 basis points (bps) increase, we are effectively where we were three years ago. But the realities are very different and that’s the savings grace. For one, we aren’t staring at slowdown of as such magnitude as was feared in August 2019. At 7.2 per cent projected GDP, the macro factors lend a helping hand. Banks are in a very comfortable position today in terms of quality of assets or capital adequacy. But what could bother them is the withdrawal of liquidity, which is happening at a faster pace than anticipated.
From ₹6.7-lakh crore surplus liquidity in April-May, it fell to ₹3.8-lakh crore in June-July. When asked whether the monetary policy committee considered the impact that such sharp withdrawal of liquidity could have on bank credit, the RBI Governor had an interesting reply.
“Commercial banks can’t give credit using central bank money. They have to mobile deposits to support credit growth,” said Shaktiknata Das, RBI Governor, in an address to media. In effect, he’s directing banks to increase their deposit rates.
But in the last two years, with interest rates at rock bottom, banks have gotten comfortable with easy money in the form of current account and savings account (CASA), and even deposits, particularly during the pandemic, have been flowing in seamlessly despite lowest ever rates. In fact, until December 2021, deposit accretion has been faster than loan growth. But that’s not the case anymore. At 14 per cent loan growth in July, it has outpaced deposit growth which was at eight per cent. What this indicates is that deployment of funds is happening faster than mobilisation, and this could soon lead to a liquidity crunch in the system. So, how will banks grow, or will they hold back the pace of growth?
While the repo rate hike has been fully passed on by banks to borrowers, depositors have had to contend with only 30-40 bps hike since May 4. With liquidity getting squeezed out sooner than anticipated, banks will have to eventually turn to depositors. As a first step, they are shoring up bulk deposits, where rates have increased by 20-30 bps since May. Though bulk deposits are seen as the easiest way to bump up liquidity, they tend to be rate sensitive as these are garnered from large corporates which deploy money as part of their treasury planning.
Banks expect to firm up their estimates on bulk deposits in a month or so. Once this settles down, turning to retail depositors (currently on the sidelines in anticipation of higher deposit rates) will be the best alternative.
Earlier, banks were guiding for retail deposit rates to increase only by November or December. “Now these assumptions have to be revisited,” said a treasury head of a private bank. With repo rate increasing by 140 bps since May 4, deposit rates may increase by 60-80 bps by September. This means that the transmission which has been quite muted so far will now gather pace.
Cost of funds have already increased by 10-20 bps for most banks, while cost of deposits hasn’t seen a jump yet. This has helped banks work with stable net interest margin (NIM). While an increasing repo rate is seen as NIM positive, after a prolonged period of sluggish demand for loans since mid-2018, we have seen a sustained recovery in the last six months.
According to a CEO of a private bank, there are already signs of slowdown in home loans. “Unless essential, customers are pushing back their purchases,” he explains. Large banks have seamlessly been able to pass on the increase in repo, while the smaller ones have absorbed some of the hikes to keep the demand buoyant. With more rate hikes in the anvil, pass through of cost may get tricky for all if they (most private banks) should maintain the growth guidance of 14-16 per cent for FY23. Unlike the situation in 2013, when bulk deposits constituted for a major chunk of total deposits, today retail term deposits have overtaken the bulk inflows.
The mix between retail and bulk deposits is now at 60:40. This was a deliberate strategy to ensure granularity of liabilities. If this mix should be intact for their long-term good, banks may have no option but sweeten the deal for depositors. Most private banks average at four per cent net interest margin. Going forward, will they latch on to profitability or growth? That’s the bankers’ dilemma.
August 05, 2022