By NR Bhusnurmath,
The State Bank of India (SBI) is in the news for raising its deposit rates. The bank’s chairman said that for deposit growth, it had taken multiple initiatives and aimed to sharpen focus on its retail network. It is also reported that the SBI made the move to avoid reliance on bulk deposits. This new-found aversion to bulk deposits, despite the convenience of lower service costs, isn’t surprising.
While presenting the first monetary policy of the current fiscal year last month, Reserve Bank of India (RBI) governor Shaktikanta Das announced that the central bank would review the liquidity coverage ratio (LCR) framework for banks to ensure smooth functioning of the system even during acute stress.
Stating that “recent events in other countries have shown that digital channels have been used by customers to quickly withdraw or transfer funds from banks”, he pointed out it is during “acute stress” events that such a framework is most required. (LCR is a prudential tool to check a bank’s ability to meet cash outflows in the near future.)
The actual LCR of most large scheduled commercial banks (SCBs) is comfortable at close to 130%, much above the minimum stipulation of 100%.
So, the governor’s observation must be read as a sign that the RBI is proactively revisiting liquidity management by banks so as to prevent any liquidity crisis.
True, there is always scope to fine-tune any prudential regulation to bring it up to speed in dealing with extreme stress events. But prevention is always better than cure. Is it possible, therefore, to devise a mechanism that enables banks to manage their liquidity (withdrawals, on a day-to-day basis) more efficiently (to avoid liquidity-driven acute stress events) rather than add to the regulatory burden?
For answers, look at what is the most likely cause of uncertainty/unpredictability of cash flows in commercial banks. Thanks to technology, customers today can withdraw or transfer funds from banks with the mere click of a button, 24/7. This means that unlike earlier when banks could make a reasonably accurate prediction about their funds position at the close of business, they can no longer do so. They are now much more vulnerable to sudden flows both ways. And while an unexpected inflow only means an opportunity cost, an unexpected and large outflow could result in a liquidity crisis.
It is here that the “traditional model” of commercial banks in India — where they raise funds through current account, savings account (CASA) giving them access to cheap funds — is both a source of strength and of weakness.
Take the latter first. Dependence on CASA leads to asset-liability mismatches (banks lend long-term but CASA deposits are short-term and, hence, inherently unstable). Inflows and outflows in CASA accounts are unpredictable. Even the best statistical forecasting models are unable to predict when a customer would want to withdraw her funds.
Now the strength. The fact is, while there is no certainty to predicting when an individual will withdraw money, at the aggregate level CASA deposits are remarkably stable. And it is the net cash inflow or outflow in all CASA deposits that has a material bearing on a bank’s liquidity position. Banks need to keep watch and arrange funds if there is a net outflow. Therefore, the liquidity risk faced by banks in India is best addressed by reducing the uncertainty in flows into and out of CASA deposits.
This is not as difficult as it might appear. Given the law of large numbers, where a bank has a high volume of CASA accounts, the probability of cash withdrawal, statistically speaking, is about 50%. Additionally, if its depositors are varied (a mix of retail, small, medium and large businesses, and so on) unlike Silicon Valley Bank (the US-based bank that went belly-up in 2023) this too adds to the stability of CASA balances. Typically, banks in India have both a large number of CASA accounts and a varied clientele — a strength compared to banks in the West.
Typically, fluctuations in CASA balances are a very small percentage of total deposits. In effect, a large portion of the CASA deposits are non-fluctuating and could even be considered “quasi-equity”. In fact, in practice, banks estimate their “core CASA deposits” and use this for long-term lending while deploying the fluctuating portion for very short-term loans.
While banks have recourse to the call money market, this may freeze in times of extreme stress. Banks in India fall back on cash reserve ratio and, in the worst case, opt to default. But that is not a good option.
Could we, instead, reconsider the case for allowing 24/7 online — particularly real-time gross settlement — transfers, as these tend to be of very high value and are usually business-related transactions that can be scheduled? Can we restrict high-value transactions to, say, 08:00 to 18:00 hrs?
Unlike retail payments that are small and often unplanned, business payments are both large and usually planned. So these can be scheduled during the day. Security market transactions, for instance, have to be done during the stipulated opening and closing hours.
Sure, there will be some inconvenience caused to businesses if high-value (beyond a set limit) online transfers are restricted to business hours, but the benefit to banks and the financial system would be enormous. Apart, of course, from reducing the potential risk to the stability of the financial system. Stable banks are essential for the financial system’s stability.
There is an urgent need for a debate on the criticality and need for 24/7 online bank transfers.
The author is adjunct professor of banking & finance, IMT Ghaziabad.
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