In a striking turn of events, Indian banks are navigating a paradox. Despite transferring a staggering $2.5 trillion, or 80% of India’s GDP, through smartphones over the past year, the Reserve Bank of India (RBI) is imposing stricter liquidity requirements for mobile-linked deposits. This move aims to safeguard financial stability but may impact credit growth and net interest margins for banks.
The Smartphone Banking Surge
More than 600 Indian banks have embraced digital banking, with customers conducting transactions via mobile numbers and QR codes. This convenience has propelled India to the forefront of global instant money transfers. However, the RBI’s new circular mandates that banks assign an additional 5% run-off factor for retail deposits enabled with internet and mobile banking. This measure, effective from April 1, aims to ensure banks maintain adequate liquid assets like cash and government securities to meet outflows.
Ensuring Liquidity Amidst Digital Growth
The RBI’s directive requires banks to reassess their liquidity needs, especially for deposits considered more “flighty.” Currently, banks estimate that 5% of stable retail deposits and similar small business funds will be withdrawn within a 30-day period. This assumption is being doubled to 10%, raising the so-called run-off factor. Consequently, banks must hold more high-quality liquid assets, reducing the resources available for lending.
CRISIL, an affiliate of S&P Global Inc., anticipates that credit growth may moderate from the expected 14% for the current fiscal year as banks bolster their liquidity buffers. Additionally, holding a larger proportion of low-risk, low-return assets could squeeze banks’ net interest margins, especially with rising deposit costs. Coupled with increasing bad loans, banks might face a triple whammy.
Lessons from the SVB Failure
The RBI’s cautious approach stems from the second-largest banking failure in US history. In March last year, Silicon Valley Bank (SVB) faced a sudden $42 billion withdrawal request from panicked depositors, driven by concerns over the bank’s investment portfolio. The digital ease with which SVB customers moved their money highlighted the risks of mobile-linked deposits. To prevent a similar scenario in India, the RBI is proactively tightening liquidity requirements, given that less than half of the deposit value in India is insured.
India’s vast and growing digital banking user base adds complexity. Out of 820 million active internet users, 370 million engage in digital banking. Younger, tech-savvy users are more likely to use mobile banking, while older demographics still prefer traditional banking methods. This demographic divergence poses a unique challenge for banks complying with the RBI’s new standards.
The Role of Brokered Deposits
While the RBI focuses on mobile-linked deposits, another potential risk looms: brokered deposits. These involve middlemen influencing savers’ choices, potentially leading to less stable deposits. Alphabet Inc., for instance, has leveraged its local payments app to channel deposits to Indian lenders, raising concerns about the durability of such funds.
Even with the RBI’s new measures, banks might find themselves stretched thin. CRISIL’s analysis suggests that the median liquidity coverage ratio (LCR) for 31 banks could drop to 117% from 136% in March, indicating a reduced ability to meet withdrawals. This strain comes at a time when credit growth outpaces deposit growth, exacerbating the liquidity crunch.
The Deposit Crunch and Its Implications
The intense competition for deposits is partly cyclical, driven by elevated interest rates to combat inflation. Banks must pass on these rates to savers to prevent them from seeking better returns elsewhere. The merger of Housing Development Finance Corp. (HDFC) with HDFC Bank Ltd. has further intensified the liquidity quest. Post-merger, the bank’s loan-to-deposit ratio surged from 88% to 114%, highlighting the pressure on deposits.
In this challenging environment, banks need to value their less tech-savvy customers more. These customers, who prefer traditional banking methods, offer stability crucial for growth and profitability. Encouragingly, their loyalty can serve as a buffer against the volatile nature of mobile-linked deposits.
