Banks need to lower dependence on bulk deposits: RBI deputy Guv Swaminathan

Mumbai: Banks should lower their dependence on bulk deposits, which are typically of higher tenor and better-priced than retail liabilities, if they want to protect their margins and profitability, especially in a higher interest rates regime, Reserve Bank deputy governor Swaminathan J said on Thursday.

Addressing a banking and economic conclave organised by the State Bank of India here, he flagged the rising tendency of banks to depend on bulk deposits and urged them to effectively manage interest rate risks, else they will have a tough time when lending rates fall but bulk deposit rates continue to remain high.

Even when interest rates decline, these long-term large deposits will still have to be managed and that can lead to lower margins eating up profit, he said. "On the liabilities side, banks must endeavour to proactively manage the pricing and duration of their deposits while trying to diversify the sources and optimising the product mix of deposits.

"Excessive reliance on bulk deposits should be avoided as these are more sensitive to interest rate movements and perpetuate concentration risk while also eroding earnings," Swaminathan said.

Warning that bankers should not feel complacent with the presently high net interest margins, he said the higher Net interest margin (NIMs) that they enjoy now may not be sustained in the future when the interest rate cycle reverses.

He said that compared to the past five years, the banking sector stands tall today, reflecting its strength and viability. As of September 2023, the capital-to-risk-weighted assets ratio of banks stood at an impressively high 16.79 per cent.

On the other hand the asset quality is at over a decadal high with gross non-performing assets falling to a low 3.25 per cent and net non performing assets (NPAs) at 0.76 per cent.

Banks need to remain alert to the risks inherent in their business models and mitigate them in a timely manner. In good times, financial institutions must review their growth plans while putting in place adequate risk management systems to handle the emerging risks, he said.

Their boards must be free to fix suitable sectoral and sub-sectoral exposure limits and monitor them closely to avoid any sectoral concentration, adverse selection or dilution of underwriting standards.

Stressing the need to have a robust IT infrastructure, he said it has become imperative for banks and payment system participants to ensure uninterrupted availability of various online and mobile banking channels at all times and pointed to the recent incidents of unscheduled downtimes inconveniencing several customers.

Flagging lower IT spending he said, it has also been observed that many banks have not been spending fully the budget earmarked for procurement of IT systems and IT security systems.

He also stressed the need for banks and other ecosystem participants to have robust disaster recovery and business continuity plans in place and test them periodically. Noting the growing collaboration between banks, NBFCs, and fintechs which is driving innovation in products, services, and business models, he said, that while such collaboration is good, banks and other financial institutions should be cautious in lending through analytics.

"Banks and NBFCs should exercise caution in relying solely on preset algorithms, ensuring that these models are robust, regularly tested, and recalibrated as needed to maintain robust underwriting standards," he said.

He also warned lenders against outsourcing risks to third parties. "... it is crucial to be vigilant on the accompanying risks which include the potential loss of control over critical operations, risk of data security breaches, heightened dependency on third-party providers, and the possibility of reputation damage stemming from the misconduct of service providers," he said.