Banks will pass higher costs to new loans: Yes Bank

Rajat Monga, chief financial officer & senior group president of financial markets, Yes Bank says banks will now pass higher cost of funds to new borrowers. Monga's view follows the RBI's put into effect various measures to remove excess liquidity from the economy.

In an interview to CNBC-TV18, Monga says Yes Bank's fall yesterday was a kneejerk reaction to the RBI’s liquidity control measures. He says the Banks exposure to wholesale funding as the reason behind the fall is just one part of the story. "It is a little bit of an uneducated guess that might be taken by the people who are saying that."
Monga adds that the high cost transmission can happen without any base rate change. Below is the edited transcript of Monga’s interview to CNBC-TV18.
Q: Yes Bank fell the most in the private banking universe yesterday because the market believes that it is exposed to wholesale funding in a bigger way and therefore stands to lose the most after the Reserve Bank of India (RBI) measures, would you concur with that inference?
A: It is less than an educated guess that people are using wholesale funding as a loosely-used term. If one looks at the asset liability management (ALM) profile of the bank, we are about 75-80 percent deposits funded and there would be about 10-15 percent of funding coming from what we call as equity and other capital sources. There is definitely repricing risks and events that happened on the liability side of any bank.
In an ALM management, the outcome of the profits or net interest margins (NIMs) is a function of what happens on the assets and what happens on the liabilities. Therefore, we have to look at both in tandem. What the market might be looking at is only a one-sided view only on liabilities.
We also have a fairly substantial floating rate loan book or a shorter-term loan book, our average tenure of loan is only about 18 months. So, there is a tandemness between assets and liabilities. We have to look at both in perspective. There is an overreaction in terms of what market is reading into what RBI is possibly intending. There might be some currently unintended consequences also which the money market is facing. So, it is a little bit of an uneducated guess that might be taken by the people who are saying that. Q: Can you tell us how much the actual wholesale cost of money would go up and how much of that you could mitigate by repricing some of the loans as you are talking about?
A: It is not wholesale. Let’s assume interest rates go higher, wholesale, retail, all funding cost will begin to move higher. So, one has to look at what is the overall net situation including asset prices moving higher. Loan yields and investment yields will also progressively move higher, if we assume that this is a permanent measure and not a transient measure that is currently being assumed.
Even if one was to hypothetically assume that, we have about 15 percent of a balance sheet which maybe gapped over a period of one year, which means that if there is one percent increase in costs across the board, there would be a 15 bps consequence on margins. That is if nothing else is done, that is if we do not increase any loan pricing out of line, that is if we do not look at any other management options that are available in fact some of these cost increase that may or may not happen will anyway get mitigated by the fact that our current account saving account (CASA) book is increasing. So, for every 4-5 percent CASA that we add to the book which we are adding for the last two years, that 4-5 percent itself will add 15-20 bps on margins. I am still not clear what is the logical argument behind what people are saying, an argument, which maybe backed by some facts and some data. It is a little bit of uneducated guess.

Q: Because of the events of yesterday though, would you say that in the near-term you will need to tweak your primary sources of funding and how differently can you do it given the events of yesterday and the implications as you alluded to as well?
A: There are no implications. It is a deposit funded balance sheet, so we have to continue to seek deposits. Wholesale funding is a misnomer. Somebody has to describe wholesale funding for us to have this discussion. Wholesale funding does not exist in India.
It is a western concept. In western countries, the banks before the global crisis would issue paper to intermediates, to hedge funds, they will have structured notes. They will have dual currency products which went into leverage balance sheets in the first place. That wholesale style of funding is absent in our country. So, all the banks are deposit funded in general.
Some deposits tend to be bulky, which is the closest we get to a sense of wholesale funding. So, for example, I have a veto right in the bank to not take bulky deposits beyond Rs 200-250 crore from a single depositor. If one looks at our top-20 depositor concentration, the number is about 13-14 percent. The best banks have about 8-9 percent on that ratio. There are many banks, including large public sector banks, that one might find in excess of 20 percent of top 20 depositor concentration. We need to understand how wholesale funding is defined in the first place. Q: The concern was that your margins may get impacted negatively. So, at this point, would you say that you are confident of maintaining the 3 percent margins you did in Q4 also taking into account the point that you were making about improving CASAs and that helping your margins?
A: Yes, absolutely. This does not even factor. Let’s assume this persists for a year. We have to also assume therefore, that this is not a temporary step that RBI is taking and therefore we have to also pass it on. So, there are still management options and we will have to be able to raise prices for our borrowers. It is too early. It is also a little bit premature to discuss that because we believe that this is a transient method which RBI is adopting to define the currency. Money markets have already eased today substantially. So, there will be a lot of dust around it, it will settle.
I believe the 75,000 crore window that RBI has artificially or quantitatively imposed may not even be needed for the next couple of months. The funding deficit of the banking sector is only 40,000-50,000 crore and falling because this is also seasonally a very liquid period. July is the best month for liquidity because of lots of the currency in circulation which leaks from bank in the busy season comes back. So, we get deposits in this period and do not get loans to compensate. Hence, there is an increase in liquidity.
We should not be reading too much into yesterday’s market reaction. It is based on some destructions, which have been speculated which might happen in the money market and that is an unintended consequence as far as our view is. Infact today, RBI has announced a small measure also to help mutual funds get repo in terms of financing because this is creating some realignment of funding in the money markets. It is a little of an unintended consequence. So, as far as the banks margins are concerned, we seem quite confident. This is not withstanding management action, we will maintain margins.

Q: Just to go back to that point about wholesale funding that you were talking about earlier, the apprehensions stem from the fact that your CASA at 18-19 percent is much lower than many of your peer banks therefore you need to have greater recourse to money market funding to run your book and therefore you might be squeezed more in the event of money market rates going up, that is pretty much the apprehension that people are talking about?
A: There is a big gap in the middle. There is CASA, there is money market funding and the big gap in the middle is time deposits. So, if one deposits the money in a fixed deposit with the bank, I deposit my money that is our primary source of funding.
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Now that source of funding is sensitive to interest rates. Even that will be repriced higher or lower. So, when we look at a funding book, we cannot look at that in isolation from liabilities. We have to bring assets again into the picture. So, let’s say we take a high CASA bank, it also has a higher retail lending share. Retail lending happens at fixed rate. If one has a car loan, a commercial vehicle loan, a construction equipment loan, credit card or personal loan, all loans are happening at fixed rates.
I need CASA funding to be matched on ALM because in India you do not have fixed rate funding for banks. We may say time deposits are fixed rate in character, but they do not have tenures in our country. The best bank in India will have 12-15 months tenure on time deposits. That is the nature of this funding structure. So, we have to therefore look at assets and liabilities in tandem.
We run a commercial lending book. Commercial lending book is predominantly floating. So, half our loan book will be repriced higher automatically in the next six months because of the residual maturity tenures representing the repricing ability of the loan book. Hence, even if the funding cost from time deposits are going to go higher - money markets is a small part of our funding portion, if the time deposits are going to be repriced higher, the loans are also repricing higher.
If some bank is lending tomorrow for a new loan, he will be charging higher irrespective of base rate. If banks were lending at 11 percent till yesterday, their base rates have not moved but I am quite confident that they will be charging 11.50-11.75 percent as soon as today and tomorrow because there is increased cost push on that side.
The ALMs, margins have to be looked at with the asset and liability in tandem. The money market’s funding is a minority, it is a 3,000-4,000 crore matter on a one lakh crore balance sheet. That is not a game changer at all. Q: Which brings us to the bigger worry that the markets were going through yesterday not just what will happen to individual banks but the fact that rates will harden in the system and a lot of banks stopped short of telling us that yesterday but you are confirming that rates are indeed going to harden because of the moves which happened?
A: The money market rates have gone up. I will also say that the reaction on yesterday is not where we can say all the dust is settled. There are distortions in the money markets at this point in time.
It is also evident from RBI action this morning where there is a repo window being opened for mutual funds. So, it is too early to even begin to conclude on whether rates will harden and rates have already hardened. If one looks at fixed income, government bond yields, corporate bond yields, commercial papers, certificate of deposits, all of them have already hardened.
The conclusion we need to make not today but over the next three-four weeks including an opportunity for RBI to communicate on their monetary policy, is towards the end of the month of July. It is only after that that we can conclude whether there is permanence to this step of RBI or whether it is a transient step like they took in the past couple of times.
If this is permanent, it will have to have an impact on cost structures, on lending yields, on all asset prices in effect. Hiking rates has been well within their scope day before yesterday. But they have chosen a structured way to approach this, which is a more directed attack on the speculators on the currency. RBI wants to make the cost of speculating higher than they have been in the past. So, it is a matter of following this waiting through this market to see how the yields are reacting, how the money markets are stabilising and they will stabilise. I do not think it is not even in RBI’s interest for money markets to remain distorted. Q: What kind of impact you expect to see on fixed deposit rates over the course of the next few months, I am just trying to understand how this particular investment works versus something even like a fixed income fund, how much higher do you think FD rates are headed in the next couple of months?
A: The main question is whether this step by RBI is transient pr persistent. If this step is transient, short-term FD rates will harden. So we, can expect a 50-75 bps hardening in the short-term, which is up to three months maybe little bit dragging six months into the picture as far as FD rates are concerned.
If we assume that the step is persisting, if this is going to be a long drawn process and is effectively a rate hike, then the stretch of tenure will increase as far as the rate impact is concerned. Whether this is a short end of the yield curve, whether it is the mid-end of the yield curve, whether it is transient or permanent, the impact is going to be in the range of 50 bps.
The RBI has now created a new rate, which is 10.25 but 10.25 is not a relevant rate. The relevant rate will be the weighted average rate between 7.25 and 10.25. That is where repo will transact over the next three-four weeks. Now, banks do have a choice. On a good day like yesterday, they took more in repo because they could increase their reserves coverage but that they will compensate over the next ten days or so in the reporting fortnight. So, there is not a funding deficit that we are calculating which will even hit this 75,000 limit on an average over the next month or so.