Opinion The case for easing banking regulations

The private sector has not been investing its surplus. The share of investment to operating cash flow for listed firms is down to 56 per cent in 2023-24 from a peak of 114 per cent in 2008-09. This could be consequent to a lack of confidence in future demand and the uncertainty caused by geopolitics.

With overseas flows muted, personal savings and investment, including overseas investments, will need to be incentivised. So, how can capital and financial intermediation efficiency be improved?

The large corporate sector is using its own surplus, equity markets, bond markets and bank credit, but MSMEs have not received their share of credit. In the last few years, banks have been incrementally getting 40 per cent or less of household savings as against 50 per cent a few years back, as consumers chase higher returns in pension fund schemes and MFs.

There are preemptions. In the last two years, banks have bought Rs 13 trillion of G-Secs against a deposit inflow of Rs 40 trillion, driven by the need to maintain liquidity coverage (LCR) and statutory liquidity ratios (SLR) as mandated by the RBI on a daily basis rather than weekly average. Banks maintain 115 per cent to avoid breach. Given the low supply of papers from manufacturing companies, which also qualify as assets for LCR, banks buy government bonds to meet LCR.

To maintain some cushion in LCR over the mandated levels, banks end up holding SLR securities of up to 26 per cent against the regulatory requirement of 18 per cent.

Banks are also required to maintain a cash reserve ratio (CRR) of 4 per cent of deposits. So, when one looks at the regulatory preemptions, they are close to 30 per cent of banks’ deposits — 26 per cent on account of LCR and 4 per cent for CRR — reducing the lendable resources for banks, leading to higher lending rates.

Under the proposed LCR guidelines for digital deposits, banks would have to invest even more in liquid assets to meet LCR, which is estimated to be about 2- 2.5 per cent of deposits.

But, do we need both LCR and SLR? Globally, only LCR exists. Most parts of the world include CRR, which earns no interest, as HQLA (High Quality Liquid Assets). The volatility of deposits calculation and consequent investment of HQLA assets needs to be examined on a bank-specific basis. Basel only recommends, we need to examine.

More efficient cash management by the government has meant that the overall liquidity available to the banking system has decreased since its surplus is parked with the RBI. This is vital for liquidity management since variation in government surpluses leads to large swings in systemic liquidity.

Banks have a priority sector lending (PSL) requirement of 60 per cent plus (this is because on 40 per cent, we have “priority on priority”), a framework drafted ages back that needs to factor in changes in GDP composition and new priorities. We need to ensure PSL pricing reflects credit risk and not pressures to meet the target.

Also, we need to examine the move to cash-flow-based lending and risk-based pricing. Otherwise, large sections of the population will be outside organised finance. Having limits on clean lending or the rate of interest or higher risk weights will not solve the problem, but supervision with extensive use of tech, including AI, will. Also, strict action should be taken against outliers and not the system as a whole.

Credit growth lower than nominal GDP growth is a major concern, and an in-depth review covering markets, regulations, banks and priorities is needed. The review should cover the funding needs of market participants’ liquidity.

Defending the rupee when the reason for weakness is the dollar’s strength needs to be examined. This leads to the reduction of liquidity, an overvalued rupee and no effective shoring-up of the currency.

The credit-to-deposit ratio calculation and its purpose should be examined. Banks need to raise both debt and equity from investors to fund growth, so they need to generate returns. They must be allowed to price for risk and processing costs.

Also, the investments in technology are huge. Technology spending by global banks (9 per cent) has outpaced revenue growth (4 per cent). Indian banks, too, are spending on building tech capabilities, with large banks reporting around 5 per cent share of tech in annual spends. Indian banks also have social responsibility costs that need to be recovered. There are a few examples: Not charging for UPI transactions, which account for a major share of bank volumes, the recovery of network costs and other reasonable bank charges. Since we are looking at international practices, a look at their charges would be a good starter.

The government bond market in India is third in emerging markets and despite the inclusion in global indices, our share is at 3 per cent compared to Indonesia’s 14.5 per cent. This makes a case for easing regulations.

The cash market looks to have adequate liquidity across the yield curve in the secondary market, but not enough in the derivatives market. For further development of the market, we need lower preemption for government securities. A nudge from regulators (IRDAI/PFRDA/SEBI) to large investors for greater use of derivatives along with cash instruments would help.

The writer, former CEO and managing director of HDFC Bank, is senior advisor to Carlyle’s Asia private equity team