Indian Banks Increase Borrowing Amidst Tighter Liquidity Conditions

Indian banks have witnessed a significant increase in their borrowings through money markets and specific bonds during the April-June quarter (Q1 FY25). This 60% surge compared to the same period last year reflects tighter cash conditions and a rising cost of funds, marking a shift from the previous era of easy liquidity.

Multiple Factors Driving Borrowing Surge

Several factors have contributed to this rise in bank borrowings:

• Tighter Cash Conditions: The Reserve Bank of India’s (RBI) efforts to withdraw monetary accommodation have led to a decrease in liquidity within the banking system. This has compelled banks to rely more heavily on borrowing to meet their funding needs.
• HDFC Bank Merger: The recent merger of HDFC Bank and HDFC Ltd has also played a role. Previously classified as a non-banking financial company (NBFC), HDFC’s borrowing liabilities are now included in overall bank borrowing data, inflating the figures to some extent.
• Data Explanation: The RBI’s fortnightly data categorises borrowings under “scheduled commercial banks” and primarily reflects short-term funding avenues like interbank lending and tri-party repos.

Additionally, instruments like additional tier-1 bonds and infrastructure bonds are included, while certificates of deposits are excluded.

Liquidity Deficit and Rising Borrowing Costs

RBI data reveals an average daily borrowing of ₹1.42 lakh crore from the central bank between May 1st and 30th, 2024, highlighting the prevailing liquidity deficit. This scarcity has driven up the weighted average call rate (WACR), a key indicator of bank borrowing costs in the money market. From August 2023 to January 2024, the WACR remained 20-25 basis points above the RBI’s repo rate, reflecting the tightening liquidity conditions.

Causes of Tighter Liquidity

Several factors are behind the reduced liquidity:

• Faster Credit Growth: The pace of bank credit disbursement has outstripped deposit growth, putting pressure on available funds.
• RBI Forex Interventions: The RBI’s interventions in the foreign exchange market to control rupee volatility have also contributed to tighter liquidity.
• 24×7 Banking Requirements: Banks are now required to maintain higher levels of precautionary cash reserves to meet the demands of 24×7 banking services.

Impact on Banks

The increased cost of borrowing has impacted banks’ profitability. Their net interest margins (NIMs) – the difference between interest income earned on loans and interest paid on deposits – have come under pressure as credit-deposit (CD) ratios have risen sharply. A higher CD ratio indicates that banks are lending out a larger portion of their deposits, potentially increasing their risk profile.

Looking Ahead

The Indian banking sector is navigating a period of transition with tighter liquidity and rising borrowing costs. As the RBI continues its monetary tightening measures, banks will need to adapt their strategies to manage their funding needs and maintain profitability.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.