Mumbai, June 5, 2013: India Ratings & Research (Ind-Ra) says that structural imbalances in the Indian banking system’s funding structure are diluting monetary policy transmission, crowding out corporates from the money market and discouraging long-term savings in the economy.
Banks’ growing dependence on short-term deposits to fund an increasing share of long-term infrastructure and residential mortgage loans has built refinancing pressures for them, making it difficult to bring down the cost of deposits. As a result, banks have been slow to reduce their lending rates – base rates for the banking system have fallen by an average 40bps since April 2012, compared with the 125bps reduction in repo rate by the Reserve Bank of India. The dilution in transmitting the monetary easing is a policy challenge as banks are the dominant source of funding to corporates and individuals.
Dependence on certificates of deposits (CDs) has also grown steadily and the Indian banking system has converted from being a net lender in the money market till 2005 to being a net borrower. The growth in CDs crowds out corporates, which see a drop in commercial paper (CP) volumes every time banks step up CD issuances. The effect has been visible since FY11, and particularly in March 2013 high CD issuances by banks led to a fall in outstanding CP, thereby exposing the limited ability of the domestic money market to fully accommodate the shift in banks’ liabilities to the short term.
The dominant share of short-term issuances compared with long-term bonds’ has affected the slope of the domestic bond market yield curve, which has been persistently flat-to-inverted throughout FY12 and FY13. This phenomenon is no longer a year-end feature but spread throughout the year, mostly on account of the continuous short-term refinancing need of banks. Such a persistently flat yield curve can dissuade long-term savings and can be a set-back for the Indian economy, which is looking to channelise long-term funds into the infrastructure sector for sustainable GDP growth.
Banks have been trying to reduce the structural imbalance by encouraging long-term deposits; however, their availability is limited to large banks. A sustainable source of long-term liabilities is therefore needed to match the growth in long-term infrastructure and residential mortgage loans. Regulations do not permit banks to issue senior bonds in the domestic market unless they are backed by infrastructure loans, which is yet to take off. It may therefore be timely to consider permitting banks to issue senior long-term debt within limits.
A balanced asset liability position and low funding gaps will reduce the banking system’s vulnerability to liquidity shocks, increase banks’ flexibility in monetary transmission and help deepen the domestic bond market.
(Source: Manager – Corporate Communications and Investor Relations, India Ratings & Research -A Fitch Group Company.)