The Monetary Policy Committee, by keeping the repo rate unchanged at 6.5 per cent by a 4:2 majority this time round, has indicated that the present elevated interest rate may be on its last legs. Opinions might be drifting towards easing of the interest rate cycle. With ECB (European Central Bank) cutting interest rates to 3.75 per cent from 4 per cent, the downward shift in interest rates is gathering pace. Though the RBI is focused on maintaining the right balance between domestic growth and inflation, synchronised action with major global central banks will be imminent.

Asset-liability management (ALM) of banks could be a challenge going forward. Banks are meeting the gaps in frictional liquidity using the liquidity windows of the RBI. Eventually, banks will have to avoid a deficit in durable liquidity. Credit growth reached 15.8 per cent year-on-year as of May 17, whereas the deposit growth was trailing, at 12.7 per cent. Such imbalance has continued since the acceleration of credit growth in FY23. However, the data on sectoral deployment of credit indicates that the excessive credit exposure to unsecured retail loans and over-reliance of NBFCs on bank funding is moderating. This will reduce the credit risk of banks.

In the context of durable liquidity, the marked shift of household savings towards physical savings could exacerbate durable liquidity risks. Also, while a young India — with a median age of 28 years in 2021 — would be beneficial to the economy, for banks it could pose certain risks. The young generation of tech-savvy customers, with good financial literacy, can further shift savings to alternative sources apart from opting for physical savings. Thus, balancing structural liquidity in banks will be daunting unless new customers are targeted with product innovation and aggressive marketing.

Strength of banks

The twin balance-sheet malaise of the past has turned into a twin balance-sheet advantage. Banks are now on a strong footing with remarkable improvement in asset quality, robust capital adequacy ratio, improved profitability, and high provision-coverage ratio.

But the growing deposit resource crunch could derail credit deployment. Banks have already increased interest rates on deposits. It is evident that against the rise of the repo rate by 250 basis points (bps), the interest rate on new term deposit rates has gone up by 244 bps ensuring full transmission of interest rates to the deposit segment. For loans, the weighted average lending rate on fresh loans increased by 204 bps. Strong banks with weak lending capacity due to insufficient incremental deposit growth could pose greater risks.

Growth, inflation, and interest rate trajectory may correct itself in times to come. However, it will be interesting to see how banks attract deposits under rising competition from non-banks including insurance companies. The RBI has called upon banks to work out different strategies and set appropriate business plans. Some of the proposed regulatory changes in the current monetary policy review could help banks. The definition of bulk deposit has changed from ₹2 crore and above to ₹3 crore and above. The RBI had already assured suitable reforms to the framework of liquidity coverage ratio (LCR) for banks to align with risks.

Allowing an auto-replenishment facility under e-mandate for recurring payments for FASTag, National Common Mobility Card (NCMC), etc., will shift some float funds from these entities to banks. Similarly, the auto replenishment of the UPI Lite wallet will also ensure the placement of funds just in time.

Product innovation, better customer service, and quick grievance redress systems will be able to improve the deposit inflows. The onus is now on banks to work out business strategies to attract and retain large-scale deposits to meet the growing credit needs of entrepreneurs.

The writer is Adjunct Professor, Institute of Insurance and Risk Management. Views are personal