Banks engaging in fierce war to raise deposits: SBI report

Things have changed significantly since the beginning of Ukraine war and the RBI rate hike cycle as it has been conscious in terms of frontloading rate hikes and calibrating excess liquidity in the system.

The average net durable liquidity injected into banking system in April that was at Rs8.3 trillion is now Rs3 trillion. In fact, with the Government spending a large part of cash balances in the Diwali week, the net LAF in the banking system that was hitherto negative has improved recently on the back of government spending and salary and bonus payments because of festive season.

Even as the banking system has moved closer to a calibrated liquidity coupled with higher signalling rates, one thing has still not changed; that is credit risk not getting adequately priced in, even as credit demand is at decadal highs and liquidity remains significantly downsized, says an internal economists' research by the SBI.

A back of envelope estimate suggests that the core funding cost of the banking system is currently at around 6.2 per cent, while the reverse repo rate is at 5.65 per cent. No wonder, banks are currently engaged in a fierce war to raise deposits, with rates being offered up to 7.75 per cent in select circumstances. Additionally, banks are currently mobilising certificate of deposits (CD) at rates as high has 7.97 per cent, for a 360 days maturity paper.

Further, few banks have raised CD at 7.15 per cent for a 92 days maturity. A significant part of the funding gap is thus also being made up by the mobilisation of CD. The outstanding CDs stood at Rs2.41 lakh crore as of October 21, as compared to just Rs0.57 lakh crore a year ago. The CP market is also witnessing significant churn with the primary issuances of the short term paper drastically reducing to Rs0.78 lakh crore after touching a high of around Rs2.9 lakh crore during November 2021.

The yield rose by 255bps since April 2022 and is at 6.92 per cent in October. It seems, with better rated corporates getting better deal directly from banks for their working capital needs, they have reduced their dependence to the short term paper.

However, what is still intriguing is that even as banking system being witness to deficit net LAF, market sources point out that risk premia over and above core funding cost are not fairly acknowledging the inherent credit risk. For example, short tenor working capital loans of less than 1 year are given even with finer rates at lower than 6 per cent linking with 1M/3M T Bill rates. 10 year and 15 year loans are being priced at less than 7 per cent. It is to be noted that 10-Yr G Sec is currently trading around 7.46 per cent, while 91 Day T Bill at around 6.44 per cent and 364 Day T Bill at around 6.97 per cent.

The good thing is that such pricing war is mostly restricted to AAA borrowers and ultimately it should also lower the risk weighted assets thereby lowering the capital requirements. It may be noted that RBI had proposed the concept of normally permitted lending limit (NPLL) for specified borrower, meant to nudge the borrowers to move towards corporate bonds market. The current trend negates such a concept as well as the logic of tenor premium. By this convention, benchmark yields should move down if we apply the logic of risk getting underpriced, as of today.

Interestingly, banks have adjusted deposit rates significantly upwards in October. Also, given that 45 per cent of bank deposits are CASA, it is only the 55 per cent of term deposits that need adjustment and hence ideally, a 190 basis point increase in repo rate could result in 105 basis point increase in deposit rate. Separately, bank deposits are either bulk, if it is more than Rs 2 crore or otherwise retail. As per RBI regulations, bulk deposits are not taken into consideration for estimation of HQLA in LCR computation. Also, there are matters of maintaining operational equilibrium that might explain high CD rates in vogue now. In the ultimate analysis, banks with better franchise and digital orientation will ensure that retail deposits triumph over wholesale deposit mobilization in the long run, coupled with the fact that meeting the LCR norms is the exclusive prerogative of mobilizing only through retail deposits.

Meanwhile, latest results of banking sector reveal that average y-o-y profit growth close to 50 per cent, and jump in net interest margin by a sharp 35 basis points. Initial results, from around 675 listed entities, show top line growing by 32 per cent with EBIDTA shrinking by 15 per cent in second quarter of FY23. It is also observed that corporates particularly in select sectors, have increased their cash holding in the half year ended September by up to 4 times as compared to September 2021. Conserving liquidity in the time of uncertainty or waiting for opportunity could be the best strategy for these corporates. Sectors such as refinery, telecom-service, cables, sugar, paint/varnish, packaging etc. have increased their cash holdings substantially. Also, sectors that had deleveraged significantly like steel, chemicals, minerals in earlier years are increasing their loan funds. The good thing is that with capex on rise, Nifty PSEs Index market cap has increased by 35.6 per cent in current year as compared to 3.52 per cent of Nifty 50 index.

Dr Soumya Kanti Ghosh, SBI Group's chief economic advisor, says, "We thus believe, it is now the opportune time to revisit the taxation of interest on bank deposits, or at least increase the threshold of exemption for senior citizens."

The RBI can also relook at the regulation that does not allow interest rates of bank to be determined as per age-wise demographics. Additionally, while there is no restriction by RBI on benchmarking of loans (as against earlier MCLR) and banks are free to use any benchmark published by FBIL, continued restrictions on not allowing negative spread on MCLR may also be removed, he said.