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Informist, Friday, Jan. 17, 2025

 

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--RBI Rao:Higher reliance on short-term liabilities may have adverse effects 
--RBI Rao: Concern on banks using wholesale funding, not deposits, for loans 
--RBI Rao: Bks must reassess liability models amid customer behaviour change 
--CONTEXT: RBI Deputy Governor Rao's comments at Mint BFSI Summit and Awards 
--RBI Rao: Imperative for NBFCs to diversify funding sources for growth 
--RBI Rao: Regulated cos must evolve stress tests for unprecedented shocks 
--RBI Rao: NBFCs must monitor FX exposure to limit funding volatility 
--RBI Rao: NBFCs should integrate FX hedging as part of asset-liability mgmt 
--RBI Rao: Bks must stay alert to risks during periods of strong econ growth 
 

 

MUMBAI – Reserve Bank of India Deputy Governor M. Rajeshwar Rao flagged regulatory concerns about liability and liquidity risks to regulated entities, including the repercussions associated with short-term liabilities at a time of deteriorating market dynamics. These risks have increased and lenders must reassess their deposit stability assumptions amid changing consumer behaviour due to the use of technology, he said at the Mint BFSI Summit and Awards 2025. 

 

Reduced reliance on retail deposits, coupled with a greater share of funding from institutional sources, is likely to result in higher funding costs and have a negative effect on profitability, he said. Using wholesale funding, instead of deposits, also leads to asset-liability mismatches in terms of tenure, Rao said. 

 

For certain banks, deposit growth has not been commensurate with the loan growth, raising concerns that disbursements by such banks are increasingly dependent on wholesale funding, Rao said. "Such imbalances are viewed as indicators for potential structural liquidity vulnerabilities," he said. However, it is necessary to conduct a holistic assessment, rather than relying on any single measure in isolation to understand the liquidity risks posed, while assessing an individual bank's asset-liability management profile, he said.

 

Rao also warned regulated entities against practices that may not pose large risks during periods of healthy economic growth, but could have serious consequences should the economy see deterioration. He cautioned that banks that are more reliant on wholesale borrowings or uninsured deposits are likely to be more vulnerable during times of economic stress, owing to rollover risks and outflows. In addition, higher funding costs associated with non-deposit liabilities may have a bigger impact on their net interest margins and credit-deposit profile.

 

"The quest to maintain margins can lead to eventual transmission of increased funding costs to interest rates on loans," Rao said. "This would either constrain growth of the loan book or may force the lenders to dilute underwriting standards and lend to riskier borrowers to maintain the earnings ratio."

 

As for non-banking financial companies, Rao raised the issue of increasing currency exposure risks, as they explore overseas funding options. While raising funds from overseas reduces a non-bank lender's reliance on the domestic banking system, providing a broader range of funding options, it could lead to "volatility in funding costs and potential liquidity strains due to exchange rate fluctuations". Therefore, Rao said, "NBFCs should integrate forex hedging with their ALM (asset-liability management) framework."

 

He added that transforming assets through securitisation to make them more liquid could also free up resources for on-lending, while serving as an important tool to improve the asset-liability management structure of non-bank lenders. Amid the rise of social media, the deputy governor said its growing reliance on the flow of information among customers could amplify their behaviour at times of crisis, possibly intensifying the crisis itself. Therefore, it is imperative for banks and non-bank lenders to reassess liability models to better predict customer behaviour, including deposit retentions and withdrawal patterns, he said.

 

As funding sources for non-bank lenders are mostly dependent on capital markets and banks, "it's imperative to diversify their funding sources while optimising borrowing costs, and mitigating the associated risks", Rao said. At the same time, regulated entities with diverse funding sources would provide unique challenges to asset-liability management, he said.

 

As the financial sector gets further interconnected, Rao flagged the need for regulated entities to develop more robust stress testing methodologies, which could enhance their ability to withstand extreme scenarios, including the amplification of shocks across the interlinked financial system. Regulated entities also need to have a formal contingency plan, clearly articulating available contingency funding sources, and the amount of funds that can be derived from these sources.  End