Basel III: LCR norms to make life tougher for Indian banks

Moneycontrol Bureau

Even as the Indian banking sector reels under a slew of recent bad news related to its non-performing assets, a quiet crisis -- of a regulatory nature -- may be brewing.

By January 2015, Indian banks will have to meet norms pertaining to liquidity coverage ratio (LCR) as prescribed by Basel III norms, starting with 60 percent, and going up to 100 percent by 2019 when the norms come into effect.

Under the LCR rules, banks will need to maintain high-quality liquid assets (HQLA) equal to one month of net cash outflows in stressed conditions.

While this may seem a way out for our stressed lenders to better tackle the bad loan menace, but maintaining such high liquidity given the large liquidity standards requirements in India, is a challenge, says a Morgan Stanley report.

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The Problem

Once LCR comes into play, banks will have to focus on stickier deposits. At the same time, on the asset side, they will have to increase the proportion of high quality liquid assets. This could constrain private banks’ lending capacity and keep rates higher for longer, pushing down profitability, the report says.

According to research firm, most large banks will be able to meet the near-term target of 60 percent. However, the bigger challenge will be improve this to 100 percent, especially as loan growth picks up. For smaller private banks their small balance sheet sizes may help. However, a marginal impact on NIM is likely, the report says.

Secondly, the Reserve Bank of India (RBI) recent monetary policy move to cut SLR (statutory liquidity ratio) requirement for banks by 50 basis points to 22 percent, will help banks move towards the Basel III guidelines. The SLR mainly comprises of government securities held by banks; and this reduction would free up close to Rs 43,000 crore of funds. But, unless RBI changes guidelines or reduces SLR rates sharply to mid-high teens by 2019, the banking industry will feel the pinch, the report says.

What needs to be fixed

Banks on their own can increase LCR by a bit, by changing the nature of wholesale liabilities. For example, more funding with no premature withdrawal clause and by keeping a close watch on stickier deposits, says the report adds.

But, the larger solution lies in the hands of RBI. As of now, RBI is not giving banks the benefit of lower reserve requirements (CRR/SLR), if that is waived on deposits outflow then LCR for large private banks will increase to nearly 80 percent. Smaller private banks will also benefit meaningfully from this move.

Agressive SLR cuts is the key. "RBI has cut SLR by about 1 percent point in the last quarter. We expect it to keep cutting SLR over the next three to four years as the LCR requirement increases. This will not imply any loosening by RBI – as banks will not be able to sell bonds, given LCR requirements," the report adds.

(Posted by Harsha Jethmalani)