RBI proposes higher liquidity coverage ratio for retail deposits, creation of level-1 high quality assets
Jul 26, 2024, 10:20 IST
The Reserve Bank of India (RBI) has issued a draft circular on the Basel III framework regarding liquidity standards, as announced in the April monetary policy, inviting comments from banks and stakeholders on the draft by August 31, 2024.
The central bank stated that banks under the Liquidity Coverage Ratio (LCR) framework must maintain a stock of high-quality liquid assets (HQLA) to cover expected net cash outflows over the next 30 days. After reviewing the LCR framework for banks in India, the RBI decided that banks should assign an additional five percent run-off factor for retail deposits enabled with internet and mobile banking facilities (IMB).
Notably, run-off rate is the percentage of outstanding balance the bank has against each type of liability, which can generate cash outflows over 30 days. This is important in situations when the bank's liquidity levels are in serious stress, or when people begin withdrawing their funds from the bank in significant numbers, adversely affecting the bank's total capital and its ability to finance such outflows.
In essence, the banks have been asked to assign an additional 5% run-off rate to all less stable deposits that have been enabled via IMB. This takes their total run-off rate to 15%, while it stays at 10% for other stable retail deposits via IMB. The addition comes in line with the increased usage of online banking, where customers do not need to physically queue up in front of banks in order to make fund transfers.
"Banking has undergone rapid transformation in recent years. While increased usage of technology has facilitated the ability to make instantaneous bank transfers and withdrawals, it has also led to a concomitant increase in risks, requiring proactive management," said RBI.
The draft circular also stated that unsecured wholesale funding from non-financial small business customers should be treated like retail deposits. The draft also proposes the creation of Level 1 HQLA in the form of government securities, which should be valued at no more than their current market value, after being adjusted for applicable haircuts as mandated under Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF) requirements.
Recently, some incidents have shown the increased ability of depositors to quickly withdraw or transfer deposits during times of stress using digital banking channels. Such emerging risks may necessitate revisiting certain assumptions under the LCR framework. Therefore, the RBI has proposed modifications to the LCR framework to facilitate better management of liquidity risk by banks.
Additionally, deposits previously excluded from LCR computation, such as non-callable fixed deposits, will be treated as callable if pledged as collateral for a credit facility or loan.
The draft circular applies to all commercial banks, excluding payment banks, regional rural banks, and local area banks, and is proposed to take effect from April 1, 2025.
Anil Gupta, Senior Vice President and Co-Group Head Financial Sector Ratings, ICRA Ltd notes that this move is likely to increase the outflows in the next 30 day bucket for banks, thereby posing higher requirements of HQLAs. Additionally, the applicability of haircuts on the government securities for inclusion in HQLA is likely to reduce the value of existing HQLAs for LCR computation.
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The central bank stated that banks under the Liquidity Coverage Ratio (LCR) framework must maintain a stock of high-quality liquid assets (HQLA) to cover expected net cash outflows over the next 30 days. After reviewing the LCR framework for banks in India, the RBI decided that banks should assign an additional five percent run-off factor for retail deposits enabled with internet and mobile banking facilities (IMB).
Notably, run-off rate is the percentage of outstanding balance the bank has against each type of liability, which can generate cash outflows over 30 days. This is important in situations when the bank's liquidity levels are in serious stress, or when people begin withdrawing their funds from the bank in significant numbers, adversely affecting the bank's total capital and its ability to finance such outflows.
In essence, the banks have been asked to assign an additional 5% run-off rate to all less stable deposits that have been enabled via IMB. This takes their total run-off rate to 15%, while it stays at 10% for other stable retail deposits via IMB. The addition comes in line with the increased usage of online banking, where customers do not need to physically queue up in front of banks in order to make fund transfers.
"Banking has undergone rapid transformation in recent years. While increased usage of technology has facilitated the ability to make instantaneous bank transfers and withdrawals, it has also led to a concomitant increase in risks, requiring proactive management," said RBI.
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Recently, some incidents have shown the increased ability of depositors to quickly withdraw or transfer deposits during times of stress using digital banking channels. Such emerging risks may necessitate revisiting certain assumptions under the LCR framework. Therefore, the RBI has proposed modifications to the LCR framework to facilitate better management of liquidity risk by banks.
Additionally, deposits previously excluded from LCR computation, such as non-callable fixed deposits, will be treated as callable if pledged as collateral for a credit facility or loan.
The draft circular applies to all commercial banks, excluding payment banks, regional rural banks, and local area banks, and is proposed to take effect from April 1, 2025.
Anil Gupta, Senior Vice President and Co-Group Head Financial Sector Ratings, ICRA Ltd notes that this move is likely to increase the outflows in the next 30 day bucket for banks, thereby posing higher requirements of HQLAs. Additionally, the applicability of haircuts on the government securities for inclusion in HQLA is likely to reduce the value of existing HQLAs for LCR computation.
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"Overall, this will pose requirements for higher liquid assets (G-secs) for the banks to shore up their LCRs, which will be adversely impacted by the guidelines. The proposed changes are positive for strengthening the liquidity position of the banks and banks are likely to build up the G-sec in run up to the implementation of these guidelines, which will further aid in achieving regulatory directives of moderating credit to deposit ratio of banks", he continued.