RBI Asks Some Banks To Curb Reliance On Short-Term Borrowings

The Reserve Bank of India has instructed some banks, including a large private bank, to course-correct on liquidity management with specific focus on asset-liability management mismatches after detecting issues in their monthly tracking of liquidity across institutions, two persons aware of the development told BQ Prime.

The RBI has cautioned them that their ALM positions were not in line. They were now managing their liquidity buckets well and based on the RBI feedback, many banks have course-corrected. They are moving to manage it better, a banking industry official said.

There are some banks, especially some smaller private banks and small finance banks, that are more dependent on market borrowings and RBI windows, which skews their liquidity profile towards short-term borrowings, another banking industry official said.

This is not an issue if it's frictional but in some cases, the RBI tracking noted that this was becoming structural, which indicated that these banks needed to build up better deposit and other liquidity buffers which would be stable in the longer term, the official said.

As per the two sources who spoke on condition of anonymity, these institutions were increasingly tapping short-tenor borrowings and the RBI windows to tide over their individual liquidity gaps, even as the overall liquidity in the system remained robust.

There are some banks that are flush with deposits and have not even unwound their bond investments, while these banks were using certificates of deposits and other market borrowings to meet reserve requirements, the sources said. 

This is intended as preliminary feedback to course correct, so that banks are aware that RBI is tracking such metrics, especially as history shows how liquidity issues, if not dealt with quickly, can spark over issues at the same entity, the second source said. 

In individual meetings and communication with such institutions, the RBI has asked these banks to bulk up their longer term borrowings so that they improve their asset-liability management profile.

However, the liquidity situation varies across institutions, with some smaller institutions dependent on market borrowings and even the RBI windows, while some large entities are sitting on excess liquidity.

In the case of one large private bank, the RBI had to showcase data to point out the dependence on short-term liquidity. The bank has since course-corrected in the last two months, the second source said.

The communication was part of periodic monitoring of the banking system’s liquidity situation by the RBI, but has coincided with liquidity driven problems in smaller banks in the US.

The US regulators on May 1 had to step in to take control of beleaguered First Republic Bank and sold its deposits and assets to JP Morgan Chase to prevent a further spillover of banking sector issues. First Republic Bank joins Silicon Valley Bank and Signature Bank as among the largest bank failures in the US, and all of these have happened in the last few months. These failures have been sparked by deposit outflows by risk averse customers despite US regulators and large banks working together to provide some liquidity support.

Although, as per records, there have been no large bank failures in India since Palai Central Bank in 1960, that is a function of the RBI stepping in often to rescue stressed institutions through forced mergers or other steps. The most recent example will be YES Bank, which was bailed out by a consortium of banks led by State Bank of India in 2020 that allowed the private bank to recover.

On the liquidity front, Global Trust Bank, which relied heavily on short-term deposits while offering long-term loans, eventually faced an asset-liability mismatch and the lender was forced to merge into public sector bank Oriental Bank of Commerce in 2004. Oriental Bank of Commerce was subsequently merged into Punjab National Bank in April 2020.