Banks are in good shape, but …

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https://economictimes.indiatimes.com/opinion/et-editorial/banks-are-in-good-shape-but-/articleshow/133634341.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

Synopsis

Banks and NBFCs face different market risk assessments. Credit growth outpaces deposit growth, widening the loan-to-deposit ratio. This trend may hide individual bank vulnerabilities when market cycles turn. Banks relying on non-deposit funding could face disadvantages. Regulators must monitor individual banks exceeding comfort levels.

Banks and NBFCs are in similar businesses. But the way the market assesses their risk profiles is different. NBFCs are riskier than banks and the differentiator is customer deposits. The Indian banking industry is in a sweet spot with bad loans at historic lows, comfortable capital and sufficient liquidity coverage. But a recent working paper from the PM’s Economic Advisory Council points to an issue that could emerge as a risk when the market cycle turns. ‘The risk map is shifting towards the liability side of bank balance sheets,’ says the paper.

A metric that provides comfort is a bank’s credit-to-deposit ratio. This has been skewed for the past couple of years. Credit growth at 19.3% and deposits at 15.4% in July are creating a ‘wedge between deposit growth and credit growth’, driving loan-to-deposit ratios above 82%. These numbers are not alarming. But there may be weaklings hiding behind robust macro numbers. Banks do substitute deposits with other funding to increase their asset size. They do need to take that risk, and it is a normal banking opportunity. But the question is whether individual banks are getting stretched. There have been instances of banks getting locked out of the markets when the tide turned, as it did during the GFC and the post-IL&FS implosion. Banks that built long-term assets with short-term funding were caught on the wrong foot, and the regulator had to step in.

The regulator may take comfort in the liquidity ratio and FCNR deposits that could improve numbers. But that will benefit only those strong banks that manage to raise those funds. Some individual banks that rely on funding other than deposits will be at a disadvantage. The regulator needs to keep a watch on those individual banks that are above the comfort level.