The Reserve Bank of India’s (RBI’s) draft guidelines of July 25, 2024, proposing to revise the liquidity coverage ratio (LCR) framework will, if implemented as is, impact the LCRs of banks by 10-301 percentage points (pps), reducing the cushion now available over the regulatory requirement of 100%, a study by CRISIL Ratings shows.

The draft guidelines propose to introduce three key changes to the LCR calculation.

First, assigning an additional 5% run-off factor on internet and mobile banking (IMB)-enabled retail deposits and certain small business deposits.

Second, restricting the value of government securities (G-secs) forming a part of Level 1 high-quality liquid assets (HQLAs) to the market value, adjusted for applicable haircuts, in line with the margin requirements under the liquidity adjustments facility and the marginal standing facility.

Third, treating deposits contractually pledged as collateral to a bank as callable, and hence included in the LCR math.

The revised norms will be applicable from April 1, 2025.

To be sure, the proposed guidelines can enhance the resilience of banks against sudden and unanticipated deposit outflows. While the implementation of the circular in its current form will result in a reduction in the current reported LCRs given the higher stress factors proposed, banks will work toward re-building that corpus.

But they will have to bear a near-term impact on credit growth and net interest margins as they shore up liquidity buffers to manage the transition.

CRISIL Ratings analysed the impact of the proposed guidelines on 31 public sector and private banks (comprising over 90% of the total assets of the Indian banking system), presuming ~75% of retail deposits are IMB-enabled. A 1% impact on the value of HQLAs due to the change in the valuation of G-secs has also been considered.

Says Ajit Velonie, Senior Director, CRISIL Ratings, “Compared with the past, and given the rising penetration of digital banking, the risk of sudden, large withdrawals during stress is higher now, thus putting pressure on liquidity. We saw instances of this last year in other geographies. The RBI’s proposed guidelines aim to increase the buffer to enable banks tackle such emerging risks. However, this revision will have an impact on current reported LCRs of many banks. The median LCR of the banks analysed, which stood at 136% as on March 31, 2024, would drop to 117% if the guideline is implemented as is.”

Further, 17 of the 31 banks analysed would have an LCR of less than 120%, compared with only three currently (see Table 1). And of this 17, nine would have LCRs of less than 110% as against none now.

The RBI move comes at a time when banks are grappling with deposits growing slower than credit. While the gap has narrowed to ~300 bps last fiscal compared with 600 bps in fiscal 2023, the initial months of this fiscal have seen the difference widening again to around 400 bps.

Many banks have been managing their funding requirements by dipping into their excess statutory liquidity ratio (SLR) holdings, among other avenues.

The LCRs of many banks have already been impacted by a reduction of more than 250 basis points in excess SLR, a key component of HQLA, between fiscals 2023 and 2024.

Says Subha Sri Narayanan, Director, CRISIL Ratings, “Banks will need to strike a fine balance between growth and profitability. While not all banks may choose to restore their LCRs to original levels, they will still need to rebuild their buffers, resulting in a two-fold impact. One, with greater investment in government bonds to shore up HQLA, resources available for lending will get curtailed, and to that extent, credit growth may moderate from the CRISIL Ratings’ projection of ~14% for fiscal 2025. Two, the higher proportion of lower-yielding G-secs in the asset mix, along with continued battle for deposits and a potential increase in deposit costs, could weigh on NIMs and profitability of banks.”