The banking industry operating at a deficit has led to a lowering of the Liquidity Coverage Ratio (LCR) with liquid assets used to finance credit growth. According to a report, the drop in LCR along with slower deposit growth may affect credit expansion and limit NIMs.
The high gap between credit taking and deposit growth was accentuated by the HDFC merger in YTD FY24.
Further, with PVBs (Private Sector Banks) leading the credit growth compared to PSBs (Public Sector Banks), the overall Credit to deposit ratio increased with PVBs maintaining it at a significantly higher level.
However, PSBs appear to be in a better position compared to private banks due to the relative size of deposits and higher levels of LCR, a CareEdge report said.
Credit taking
The credit consumption was around 16% for FY23 and around 20% for YTDFY24 after considering the merger of HDFC Limited. Excluding the merger, credit growth was still around 16% YTDFY24 (yoy). Banks focused on retail lending and the demand was driven mostly by the personal loans (ie retail loans) and services (especially NBFCs) sector.
Retail accounted for about 34% of total credit outstanding in December 2023 while industry and services accounted for 29% and 24% respectively. The PVBs grew faster than PSBs. Meanwhile, on the other hand, deposit growth was around 13%. In the initial part of the pandemic, deposit growth exceeded credit growth and in the later part, credit growth was faster than deposits. This momentum continued and the HDFC merger accentuated the difference between credit and deposits. Consequently, the gap between credit and deposit growth continued and remained elevated.
Credit growth lagged deposit growth for FY21 and FY22 but credit growth witnessed an increase while FY23 and YTDY24 broadly outpaced deposit growth. As a result, the Credit to Deposit (CD) Ratio increased to about 81% with a higher CD ratio for private banks at about 94% and for public banks at about 74%.
However, it should be noted that this level is not exactly unprecedented but almost similar to pre-Covid levels during March 2019. The CD ratio for private banks after adjusting for the merger effect stood at 86% in September 2023. The CD- ratio is predicted to be under pressure due to the continued lag of deposit growth against the speed of credit expansion with the general optimistic growth forecasts of the economy.
Liquidity risk
Liquidity risk indicates the potential struggle that a business might face in meeting its short-term financial obligations due to an inability to convert assets into cash without incurring a large loss. Liquidity risk is generally characterized by two main aspects: market liquidity risk and financial liquidity risk. Financial liquidity risk refers to the inability to obtain sufficient funding to meet financial obligations. After the 2008/9 crisis, the Basel Committee on Banking Supervision (BCBS) recommended the adoption of the LCR and the net stable financial ratio (NSFR) towards the end of 2010. The purpose of LCR is to reduce banks’ reliance on short-term, volatile funding sources that may be subject to volatility risks.
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