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Business, Equities, Market News, Markets - January 6, 2025

Liquidity Deficit in the Banking System

Liquidity Deficit in the Banking System

India’s banking system liquidity slipped into a deficit in December of 2024, making it the first shortfall since June of the same year even after easement of the CRR by RBI which infused Rs. 1.16 lakh crore. The banking system liquidity deficit reached Rs. 2.43 trillion as of 23rd December, 2024. This meant that banks did not have sufficient funds to lend and sustain day to day operations.

There are numerous reasons as to why despite RBI efforts, banking system liquidity has reduced significantly. One of the pressing reasons for this reaction would be the issue of advance tax payments, that is, businesses have made sizable amounts of tax payments which reduced the cash in circulation within the banking system. Another major factor is the RBI’s regular interventions in the foreign exchange market. Recently, the RBI sold U.S. dollars to stabilize the rupee which then led to the erosion of rupee liquidity in the near term with crossing new lows multiple times reaching Rs. 86.51 to a dollar this tuesday (31st, December, 2024). Furthermore, the factor that influenced banking system liquidity is the festive spending season which led to increased cash withdrawals by individuals, decreasing the deposits held with banks. This type of seasonal demand is typical but can put stress on liquidity during peak times. Another factor linked to liquidity crunch is the decline of currency in circulation in the economy, which increased to more than Rs. 500 billion in 2024 which further limited the available funds with banks.

The liquidity shortfall comes after many fluctuations in liquidity in the past one year. The RBI addressed this deficit by way of policy actions which included a 50 basis point cut in the CRR to 4% from 4.5% in December which injected around Rs. 1.16 lakh crore but this is not enough to offset the cash withdrawals and interventions. This CRR requirement came into implementation in two tranches of equal basis points, one from 14th December and 28th December.

Despites the liquidity shortfalls, RBI utilized variable repo rate (VRR) auctions to stabilize borrowing costs close to policy repo rate. During the month of December, average call rate has been around 6.55% which happens to be just 5 basis points above the repo rate. On the other hand, experts have stated managing call rates through VRR auctions is only a temporary solution in handling liquidity in the economy.

While commenting on the liquidity issue, Siddhartha Sanyal, chief economist at Bandhan Bank, stated that for the situation to improve, government spending should increase significantly in Q4. Further, the CRR requirement rate cut would also impact liquidity in a positive manner. In the near term it would be important to meticulously eye the trends in USD-INR and the near possibility of RBI intervention in the foreign exchange market which is possible in upcoming weeks/months.

Coming to the journey of rupee so far this year, rupee’s trajectory has been weakening from the past few months, with rupee slipping below record lows at numerous occasions. Furthermore, India’s foreign exchange reserves have depleted by almost USD 60 million by 20th December, 2024 which shows RBI continuous intervention in the foreign exchange market.

Additionally, to counter persistent liquidity crunch in the banking system, RBI has already hinted on further rate cuts in the first half of 2025. Market experts have stated that liquidity deficit can affect the credit flow which limits the impact of any further rate reductions. Another tool the RBI could employ to ease the liquidity is the Open Market Operations (OMO). RBI could do this by announcing the open market bond purchases which would further induce liquidity directly into the economy by way of government bond issuance. Looking ahead, market participants expect spending to expand by about ₹1 billion from January to March 2025. This increase in demand will be driven by other sources, inflation and other monetary factors are involved and thus the demand for funds may increase, whereby the liquidity of the system becomes tight again.

In conclusion, the deficit in the Indian banking system by December 2024 is a significant development, which means that sustainable measures are needed to ensure liquidity in the coming months, though RBI has already taken steps to address the issue, including reducing CRR and variable rate repo auctions. The idea is to stabilize the monetary environment by implementing innovative measures such as market bond purchases and further reductions in CRR necessary as the monetary system faces ongoing pressures from financial flows, currency circulation and foreign currency intervention, therefore to ensure access to funds appropriate, it will be critical to the successful delivery of monetary policy and overall financial health.

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Business, Equities, Market News, Markets - December 24, 2024

Bank Deposit Rates Unlikely to Decline Amid Strong Loan Demand

Bank Deposit Rates Unlikely to Decline Amid Strong Loan Demand

Bank deposit interest rates in India are expected to remain steady through the remainder of FY25 as banks grapple with heightened credit demand and tighter liquidity conditions. Despite a recent cut in the cash reserve ratio (CRR) by the Reserve Bank of India (RBI), lenders are unlikely to lower deposit rates significantly, given the need to mobilize funds for a seasonally strong credit demand in the fourth quarter.

CRR Cut Offers Limited Relief
The RBI’s reduction in the CRR by 50 basis points earlier this month released an estimated ₹1.16 lakh crore into the banking system, temporarily easing liquidity pressures. However, this move is insufficient to offset broader systemic liquidity challenges. “While system liquidity is likely to continue to be in deficit in December 2024, the recent CRR cut by the RBI should provide some relief. Deposit rates are unlikely to show a material decline as the busy credit season lies ahead,” noted Karan Gupta, Director – Financial Institutions at India Ratings.

Liquidity Challenges Persist
As of mid-December, the banking system’s liquidity situation has deteriorated significantly. Liquidity swung from an average surplus of ₹25,000 crore in early December to a deficit of ₹1.11 lakh crore by December 16. This steep decline was largely attributed to quarterly advance tax payments by corporates, which drained liquidity from the system. The persistent deficit is expected to keep short-term rates elevated, with experts noting an increase of 5-10 basis points in short-term borrowing costs compared to early December levels.

Deposit Growth Matches Credit Growth
On the deposit side, growth has finally converged with credit growth, both clocking an annual increase of 10.6% and 10.7%, respectively, as of November 29. This convergence is a positive development for the banking system, as it alleviates the earlier mismatch between credit expansion and deposit mobilization. Nonetheless, maintaining this balance is critical, especially during periods of heightened loan demand.

Credit Demand Peaks in Q4
Traditionally, the fourth quarter sees a surge in credit demand driven by working capital requirements and seasonal business needs. This year is no different, with the banking system reporting a year-on-year credit growth of 10.6% as of November-end. Although this is a moderation from the double-digit growth observed earlier in FY25, the demand remains robust enough to exert pressure on banks to sustain elevated deposit rates to attract funds.

Marginal Impact on Bank Margins
The CRR cut has a nuanced impact on bank profitability. According to Soumya Kanti Ghosh, Group Chief Economic Adviser at the State Bank of India, “The reduction in CRR may not mathematically translate to any change in deposits and lending rates. However, it may have a positive impact on margins of 3-4 basis points for banks.” This modest improvement in margins provides some relief but does not fundamentally alter the funding cost dynamics for banks.

Rising Reliance on High-Cost Funding
To meet funding requirements, banks have intensified their efforts to attract deposits by offering higher term deposit rates. Additionally, many lenders have turned to certificates of deposit (CDs), a relatively costlier funding avenue, to bridge liquidity gaps. “Deposits have remained prominent in FY25 as banks have intensified efforts to strengthen their liability franchise and have offered higher term deposit rates,” said Sanjay Agarwal, Senior Director at CARE Ratings. “The banks are additionally obtaining funds through certificates of deposit, albeit at a comparatively higher expense.”

Funding Conditions to Remain Tight
Experts broadly agree that funding conditions for banks will remain tight in the foreseeable future. While deposit rates have likely peaked, they are expected to stay elevated as banks compete to secure funds amid volatile liquidity conditions and strong credit demand. The need to maintain an adequate liability base to support credit growth means that any reduction in deposit rates is unlikely before the end of FY25.

Implications for Borrowers and Depositors
For borrowers, the stable to marginally higher interest rate environment could mean higher borrowing costs, especially for short-term credit facilities. On the other hand, depositors stand to benefit from attractive term deposit rates, as banks continue to offer competitive returns to secure funds.

Outlook for FY26
As we approach the end of FY25, the outlook for FY26 hinges on several factors, including RBI’s monetary policy stance, global interest rate trends, and domestic economic conditions. If liquidity conditions improve and credit growth stabilizes, there may be room for banks to reassess deposit rates. However, the current environment suggests that deposit rates will remain a focal point for banks to navigate through the immediate challenges.

In summary, while the CRR cut has provided temporary relief, the interplay of strong credit demand, volatile liquidity conditions, and external pressures will likely keep deposit rates elevated in the near term. Banks will need to carefully manage their funding strategies to sustain growth and profitability in this challenging environment.

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Business, Equities, Market News, Markets - December 18, 2024

Mixed Reactions in NBFC Stocks Post RBI's CRR Cut

Mixed Reactions in NBFC Stocks Post RBI’s CRR Cut

The Reserve Bank of India’s (RBI) recent decision to cut the Cash Reserve Ratio (CRR) by 50 basis points has injected liquidity into the banking system, but its impact on Non-Banking Financial Companies (NBFCs) has been mixed. While leading NBFCs like Bajaj Finance witnessed a stock price rise of around 4%, and gold loan players such as Muthoot Finance and Manappuram Finance saw gains, other segments, including NBFC-Microfinance Institutions (MFIs), experienced declines. This uneven response underscores investor caution, with decisions being made on a case-by-case basis rather than an industry-wide optimism.

Declining Bank Lending to NBFCs: A Closer Look

The slowdown in bank lending to NBFCs is not surprising, given the regulatory headwinds the sector faces. Several factors have contributed to this trend:

Increased Risk Weightage: Last year, the RBI increased the risk weightage on NBFC loans by 25 basis points to 125%. This move made loans to NBFCs more capital-intensive for banks, discouraging lending.

Liquidity Coverage Ratio (LCR) Norms: Proposed changes in LCR norms require banks to maintain a higher proportion of liquid assets. Additionally, a 5% runoff factor on retail deposits facilitated through digital platforms has further constrained funds available for lending to high-risk borrowers, including NBFCs.

RBI Warnings: The central bank’s repeated cautioning about rising exposure to high-risk NBFCs has nudged banks to reduce their lending.

Data Speaks: A Grim Outlook

The impact of these measures is evident in RBI’s data on bank lending to NBFCs. Bank lending to the segment has contracted by 0.7% until October 18 this fiscal year, compared to a robust 7.6% growth in the corresponding period last year. Year-on-year growth also plunged sharply to 6.4% as of October-end, down from 18.3% in the previous year.

In absolute terms, lending fell to ₹15.3 lakh crore from ₹15.5 lakh crore. The fallout has been particularly severe for smaller, low-rated NBFCs (rated AA and below), which are more reliant on bank funding. In contrast, larger, top-rated NBFCs have turned to alternative sources such as the money markets to meet their funding needs.

RBI’s Concerns About NBFC Loan Books

The RBI’s discomfort stems largely from the nature of NBFC loan portfolios, which are heavily tilted towards high-margin, high-risk unsecured loans. While these loans have been lucrative for NBFCs due to their ease of disbursal and attractive margins, they also pose significant risks during economic downturns. Rising defaults in these segments can lead to a surge in non-performing assets (NPAs), potentially affecting the balance sheets of both NBFCs and their lending banks.

In response to the RBI’s warnings, both banks and NBFCs have started curbing their exposure to unsecured loans. This is a necessary but challenging transition for the industry as it seeks to balance profitability with prudence.

Moderation in Industry Growth

According to a December 2 note by rating agency Crisil, growth in assets under management (AUM) for NBFCs is expected to slow to 15-17% in the current and next fiscal years. This marks a decline of 600-800 basis points from the strong 23% growth seen last fiscal. While this projected growth is still above the decadal average of ~14% (fiscal 2014-2024), it signals a cooling off as NBFCs adapt to evolving regulatory and operational dynamics.

Crisil identifies three key factors contributing to this moderation:

Rising Household Indebtedness: Concerns around rising debt levels and associated asset quality risks are forcing NBFCs to recalibrate their growth strategies, particularly in segments like microfinance and unsecured loans.

Enhanced Regulatory Compliance: Stricter norms on customer protection, pricing disclosures, and operational compliance are increasing costs and complexity for NBFCs.

Diversified Funding Challenges: Access to diversified funding sources has become a critical determinant of growth. With bank lending slowing, smaller NBFCs face significant challenges in raising funds, unlike their larger counterparts who have access to corporate bond markets and external commercial borrowings (ECBs).

Will the CRR Cut Boost Bank Lending?

The CRR cut is expected to inject ₹1.16 lakh crore into the banking system, but its impact on NBFC lending may be limited. The fundamental reasons for the slowdown in bank lending—RBI’s concerns over the high-risk nature of NBFC portfolios and the proposed LCR norms—remain unchanged.

According to Sanjay Agarwal, Senior Director at CARE Ratings, top-rated NBFCs are unlikely to turn back to banks for funding anytime soon. These companies are securing cheaper funds from overseas bonds and ECBs, even after accounting for hedging costs. They also benefit from robust supply in the domestic corporate bond market and private sources like Alternative Investment Funds (AIFs) and family offices.

Smaller, low-rated NBFCs, however, continue to struggle. Banks typically avoid lending to such entities due to their perceived risk. This dynamic is unlikely to change in the near term, despite the additional liquidity in the banking system.

Looking Ahead: A Glimmer of Hope in 2025?

The lending landscape may shift if interest rates decline significantly in 2025. The RBI is expected to ease rates by 50-75 basis points next year, provided inflation sustains below 5%. Lower rates could make bank loans more attractive for top-rated NBFCs, potentially reviving lending activity. However, this recovery would depend on broader economic conditions and the ability of NBFCs to align with regulatory expectations.

Conclusion

The RBI’s CRR cut has provided immediate liquidity to banks but has done little to alleviate the structural challenges facing NBFCs. With regulatory pressures mounting and access to traditional funding sources narrowing, the sector is navigating a period of recalibration. While larger, well-rated NBFCs continue to find alternative funding avenues, smaller players face significant hurdles. The road ahead will depend on how effectively the sector adapts to these challenges and the trajectory of interest rates in the coming years.

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Business, Equities, Market News, Markets - December 9, 2024

RBI Maintains Neutral Stance: Balancing Inflation Risks and Growth Slowdown

RBI Maintains Neutral Stance: Balancing Inflation Risks and Growth Slowdown

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) extended its status quo on policy rates in its latest meeting, keeping the repo rate unchanged at 6.50%. The decision, supported by a majority vote of 4 out of 6 members, underscores the central bank’s cautious approach in managing inflation risks while ensuring sustained economic recovery. Notably, two members voted for a 25 basis points (bps) rate cut, reflecting concerns over the ongoing growth slowdown.

Inflation Concerns Shape Policy Decision
The RBI’s decision to maintain its neutral stance stems from an uptick in inflationary pressures. The central bank sharply revised its baseline Consumer Price Index (CPI) inflation forecast for Q3 FY25, raising it by 0.9 percentage points. Similarly, the full-year inflation forecast has been increased by 0.3 percentage points, highlighting persistent price pressures.

RBI Governor Shaktikanta Das reiterated the significance of price stability, emphasizing its role in supporting sustained growth. “High inflation adversely impacts consumption and investment activity,” he noted, signaling the MPC’s vigilance in managing inflation expectations. The October CPI print of over 6%—driven primarily by food inflation—further underscores the need for caution.

Revised Growth Projections Reflect Slowdown
Acknowledging weaker-than-expected economic performance in the first half of FY25, the RBI lowered its full-year GDP growth forecast from 7.2% to 6.6%. The second quarter witnessed a seven-quarter low in growth, prompting a recalibration of projections.

Despite this, the RBI projects a rebound in the latter half of FY25, with real GDP growth expected to rise to 7% in H2 FY25. Governor Das expressed confidence in the recovery, citing early signs of improvement in high-frequency indicators such as rural demand, government consumption, and external trade.

Liquidity Measures to Support Growth
In a move to address liquidity challenges, the RBI announced a 50 bps reduction in the Cash Reserve Ratio (CRR), bringing it down to 4% of banks’ net demand and time liabilities. This measure, last implemented in April 2022, is expected to inject approximately ₹1.16 trillion into the banking system.

This liquidity infusion aims to counter tightness arising from the RBI’s dollar sales to stabilize the rupee. Current estimates suggest a durable liquidity surplus of ₹1.88 trillion, significantly lower than the ₹4.88 trillion recorded in early October.

The CRR cut complements other liquidity-enhancing measures, such as raising the ceiling rate on Foreign Currency Non-Resident (Bank) [FCNR(B)] deposits by 1.5% above the reference rate until March 2025. This move seeks to attract higher capital inflows amidst declining foreign portfolio investments (FPIs) and net foreign direct investments (FDIs).

Inflation and Growth Outlook
Inflation Trajectory:
The RBI’s revised inflation projections signal a cautious outlook. Headline inflation is expected to average 5.7% in Q3 FY25, up from the previous estimate of 4.8%. Over the subsequent two quarters, inflation is projected to moderate to 4.55%, before aligning with the RBI’s 4% target in Q2 FY26.

Food inflation, a key driver, is anticipated to ease with the arrival of the winter crop and improved supply chain dynamics. However, the potential for second-round effects from elevated food prices remains a concern. Surveys indicate that input and selling prices could firm up in Q4, necessitating close monitoring of inflation data in the coming months.

Growth Prospects:
Despite the downward revision in growth forecasts, the RBI remains optimistic about a recovery. Factors supporting this outlook include robust Kharif production, favorable Rabi crop prospects, and an uptick in investment activity.

High capacity utilization in the private manufacturing sector and the government’s fiscal space for increased capital expenditure are expected to bolster growth. Additionally, resilient global trade and buoyant services demand are likely to sustain external and urban consumption, although geopolitical and geo-economic uncertainties pose risks.

Policy Implications and the Road Ahead
The MPC’s cautious approach suggests that policy easing in the February 2025 meeting will hinge on inflation and growth dynamics. With inflation projected to remain above the 4% target until mid-2025, any rate cuts will depend on a durable reduction in price pressures.

The infusion of durable liquidity through the CRR cut provides the RBI with the flexibility to monitor macroeconomic conditions. Financial conditions remain supportive, as evidenced by strong bank credit growth surpassing nominal GDP growth and robust credit deployment across key sectors.

The National Statistical Office (NSO) will release advance GDP estimates before the next MPC meeting, offering critical insights into underlying economic momentum. While the baseline trajectory suggests room for a cumulative 50 bps rate cut under a neutral stance, persistent inflationary pressures could delay monetary easing. Conversely, if growth underwhelms, the MPC may adopt an accommodative stance, potentially enabling up to 100 bps of rate cuts over the next year.

Conclusion
The RBI’s latest policy decision reflects a balanced approach, prioritizing inflation management while addressing growth concerns. By maintaining a neutral stance and implementing targeted liquidity measures, the central bank aims to navigate a challenging macroeconomic landscape. The trajectory of inflation and growth in the coming months will be crucial in determining the MPC’s future course of action. For now, the RBI’s cautious optimism provides a foundation for sustaining economic recovery amidst global uncertainties.

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