The Reserve Bank of India (RBI) released draft norms on July 25, outlining new liquidity standards under the Basel III framework. The new regulations suggest that banks will need to apply additional risk weightings to deposits made through internet and mobile banking (IMB).

Specifically, deposits will be categorised with risk weights of 5%, 10%, or 15%, depending on their stability, with 10% applied to stable deposits and 15% to less stable ones.

Valuation of Level 1 High-Quality Liquid Assets (HQLA)

Under the proposed guidelines, Level 1 High-Quality Liquid Assets (HQLA) must be valued at no more than their current market value.

These assets will be adjusted for applicable haircuts, in accordance with margin requirements under the Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF).

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Deposits pledged as collateral for a bank facility or loan will not be included in the Liquidity Coverage Ratio (LCR) computation.

Understanding the Liquidity Coverage Ratio (LCR)

The Liquidity Coverage Ratio (LCR) is a measure that ensures banks maintain a buffer of easily liquefiable assets to cover potential withdrawal demands over a 30-day period.

Banks are required to hold these assets, such as government bonds, to meet anticipated withdrawals.

The new draft norms address changes brought about by the rise in internet and mobile banking, which has increased the speed and frequency of withdrawals, leading to a decrease in easily available savings deposits.

Impact on stable and less stable deposits

The RBI’s new draft norms propose that banks increase the liquidity cover for ‘stable deposits’—those from which withdrawals are infrequent—from 5% to 10%.

For ‘less stable deposits,’ which are more prone to withdrawal, the required liquidity cover will rise from 10% to 15%.

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This adjustment aims to address the challenges posed by the growing use of digital banking platforms, which have altered traditional deposit behaviors.

Treatment of term deposits

Term deposits, which banks prefer due to their longer tenure and lower liquidity requirements, will be affected if used as collateral for borrowing.

These deposits will now be treated similarly to retail deposits, necessitating a liquidity cover of 10% or 15%, depending on their category.

Valuation of government bonds

The RBI’s guidelines also require that the valuation of government bonds used to maintain liquidity be based on their current market price, rather than their printed price.

This change aims to ensure that banks hold accurate amounts of liquid assets.

Sector-wide impact and bank responses

The implementation of these norms is expected to require banks to allocate an additional ₹5-6 lakh crore into government bonds.

This change will become effective in the next financial year, allowing banks time to adjust and provide feedback.

While the increased allocation to government bonds may impact banks’ margins and deposit costs, the actual impact will depend on the banks’ ability to adjust their liquidity management strategies.

Analysis of potential effects on banks

Rikin Shah, Vice President of IIFL Securities, noted that the rise in digital transactions could accelerate deposit withdrawals during stressed periods, prompting the RBI to adjust liquidity requirements.

IIFL Securities’ analysis indicates that around 80% of total retail deposits, which are digitally enabled, will be impacted.

For Public Sector Undertaking (PSU) banks, the impact may be slightly less.

IIFL Securities also highlighted that PSU banks have reduced their LCR by 15-20% over the past two years, with an LCR of 130%, which is still higher than the 120% maintained by private banks.

The draft guidelines may reduce the proforma LCR by 10-20%, potentially leading to margin compression and earnings impact.

Banks such as Federal Bank and IDFC First Bank could see their LCR fall below the regulatory minimum of 100%.

Conclusion

The RBI’s draft norms represent an incremental challenge for the banking sector, with implications for liquidity management and margin pressures.

However, the final impact will depend on feedback from banks and any subsequent adjustments to the guidelines.

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