Private Banks' Capital Buffers And Loan-To-Deposit Ratio Under Strain

Private banks' capital adequacy ratio and common equity Tier-1 ratio fell in the third quarter after the Reserve Bank of India's clampdown on unsecured personal loans.

Lenders who saw a sequential decline in CRAR include Axis Bank Ltd. (121 basis points), ICICI Bank Ltd. (146 bps), Kotak Mahindra Bank Ltd. (50 bps), Federal Bank Ltd. (48 bps), and Yes Bank (100 bps).

On Nov. 16, the RBI raised credit risk weights on unsecured consumer loans, directly impacting banks and non-bank financial companies’ capital adequacy ratio as they had to set aside higher capital against such loans.

And that’s what has become the primary reason for a lower CRAR in this quarter, according to analysts. However, the impact is not expected to last for long.

The impact on CRAR is a one-time adjustment only and should start improving from the next quarter, according to Suresh Ganapathy, managing director at Macquarie Capital Securities.

However, this fall may increase some banks' need to raise capital as they reach closer to optimal threshold levels—all to keep some buffer, said Anand Dama, head of BFSI research at Emkay Global Financial Services Ltd.

"For larger private banks, the optimal CET-1 ratio is around 14%," he said.

Lending is also expected to get tougher, and banks may increase interest rates in order to maintain their margins.

Amid intense competition to gather deposits and tight liquidity, another challenge that private banks may be looking at is maintaining an optimal loan-to-deposit ratio. It's a measure of whether a lender can manage loans from its deposits or has to borrow funds from the market. Borrowed capital narrows margins for lenders.

The system credit growth is 16% year-on-year and deposit growth is 13% year-on-year for scheduled commercial banks, according to the latest RBI data.

Without taking into account HDFC Bank Ltd.'s merger with Housing Development Finance Corp., the system's credit growth is 15.6% year-on-year and deposit growth is 12.3%, according to the data.

For private sector banks a current LDR of more than 87% leads to an incremental LDR of approximately 105%, even assuming no private lender grows in line with the system, Bernstein said in a Jan. 30 note. "Such a high incremental LDR is unsustainable."

Lenders that saw a rise include ICICI Bank (73 bps), Kotak Mahindra Bank (113 bps), Federal Bank (33 bps), and Yes Bank (68 bps).

Axis Bank's LDR, however, declined 120 basis point sequentially. In an analyst call, the bank said it raised large deposits through the quarter. Even on the LCR side, it has operated within the 115 to 120 basis point band, and it has been within this band for last 18 quarters.

NDTV Profit previously reported that the competition for gathering deposits is getting intense, and public sector banks have managed to raise their deposit rates much faster than private sector lenders.

LDR going up also becomes a concern as it shows that banks are funding themselves more from borrowings than deposits, said Amit Khurana, head of equity and research at Dolat Capital.

"If a bank's LDR is going up, it indicates that the deposit market is tight and CASA deposits have not been strong. Investors are concerned about how banks will fund their books to lend further. It is important for LDR to be at an optimal level," he said.

An optimal level of LDR would be between 80-85%. For LCR, according to Khurana, an optimal ratio would be 70–72%.

The best way of normalising this would be a hike in lending yields and deposit rates, according to the Bernstein note. This would drive equilibrium without hurting any margins, it said.

This, however, may face a challenge due to the current loan mix of public and private sector banks. Since private banks have moved their loan book to an external benchmark-linked lending rate, their ability to raise lending yields is limited.

A combination of tight liquidity and aggressive deposit pricing by PSBs could also result in slower deposit growth for private players, which could further constrain loan growth, the note said.

The central bank's upcoming monetary policy outcome would be something to look out for, according to Khurana.

"LDR and LCR have to be an optimal ratio, and I suspect that the RBI will react to this in the upcoming MPC meeting. Afterall, the market is very tight for banks to raise deposits," he said.