Banks may alert RBI as rising funding costs sting amid ​sustained liquidity drainage

Mumbai: Banks are likely to make representations to the Reserve Bank of India (RBI) on sustained liquidity drainage that has pushed up funding costs for lenders despite unchanged policy rates for nearly a year. Liquidity has steadily declined with the central bank repeatedly stressing the primacy of maintaining price stability as Indian voters get ready to elect their next government this summer.

“Banks and other participants in bond and interest rate markets will send a representation on the issues on Liquidity Coverage Ratio (LCR) buffers and high cost of funds to the RBI,” a source told ET.

“This will be done next week, ahead of the policy statement on February 8,” the source said.

LCR refers to a post-global financial crisis norm that requires banks to maintain high quality liquid assets (HQLA) to meet 30 days of net fund outflows under conditions of stress.

HQLA are primarily made up of government securities, a buffer corpus banks are now dipping into to meet increasing demand for credit amid an increasingly evident liquidity deficit.

As on Friday, the liquidity deficit in the banking system was at ₹2.14 lakh crore. Liquidity in the banking system has broadly remained at a deficit for the past five months, pushing up banks’ costs of funds much above the RBI’s policy repo rate, which is where the cost of funds should theoretically be.The RBI has been maintaining tight liquidity to curb inflation, a politically sensitive metric that needs restraining, especially as the most populous country embarks on the biggest democratic exercise in the world to choose its government for the next five years. On Friday, the overnight call money rate, which represents banks’ cost of funds, closed at 6.80%, far above the repo rate of 6.50%.

For banks, the tight liquidity is likely to hit net interest margins (NIMs) going ahead, as the cost of financing loans goes up sharply. The RBI has over the past few months stressed upon the need for better transmission of the rate increases it has carried out from February 2022 to March 2023. Over the past few weeks, the RBI has stepped up variable rate repo auctions to give banks short-term funds. However, the central bank would need to increase the quantum of such fund injections to bring down overnight rates meaningfully, bankers said.

Margins & Buffer Drawdowns
“There is an issue with maintenance of LCR because banks are now dipping into government securities for funding purposes. Further, margins are being hit as spreads between funding avenues like 1-year Treasury Bills and CD (certificates of deposit) rates are at all-time highs,” the source said.

The buffers are thinning, however. Given that Indian banks also need to hold government bonds under the Statutory Liquidity Ratio, the RBI lets banks use a portion of the SLR bonds for computation of LCR.

In the current situation where banks are facing pressure for funds, they have been using their holdings of government bonds – either by selling them or entering repurchase agreements – to raise money and finance loan growth. In its third-quarter earnings, HDFC Bank said its LCR fell to 110% versus 121% in the previous quarter, with analysts citing the reduction as one of the factors that contributed to a post-earnings slump in the lender’s share price. Banks are required to maintain 100% LCR.

On Wednesday, the cutoff yield on the 364-day Treasury Bill issued by the government was set at 7.15%. Meanwhile, on Thursday, the National Bank of Agricultural Development issued one-year CDs at 7.89%.

The gap represents the difference between banks’ returns from T-bills and the interest paid to raise funds through CDs.

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