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Systemic weaknesses in the Indian banking sector imminent
July 18, 2023
The Reserve Bank of India’s FY23 closing balance sheet reveals that the Indian economy has normalised and the coordinated fiscal-monetary reaction to Covid-19 may have been successful. However, signs of weaknesses are now emanating from across the system, and Q1 FY24 may augur an impending shock, if the RBI does not remain vigilant.
Amidst capex-driven growth and somewhat robust yet waning consumer confidence, liquidity has become the first casualty. Understandably, credit offtake continues to outstrip growth in public deposits, and systemic liquidity is currently just a quarter of what it was at the same time last year.
At the same time, demand at the Marginal Standing Facility (MSF) has now increased 40-fold, and this signifies liquidity inadequacies in the non-collateralised and money markets. Likely, this has a direct bearing on smaller and vulnerable commercial banks, which might have to struggle for liquidity and encounter higher stress levels.
The overall decline in the cost-effective current account savings account (CASA) deposits among commercial banks in relation to time deposits has not helped the cause either.
Secondly, in a bid to control inflationary tendencies, and partly due to currency withdrawal, the RBI has not expanded its balance sheet through Q1 FY24. This has resulted in no net additional printing of new money, in line with the expanding economy’s needs. Given the high growth in credit offtake, bank reserves with the RBI are continuing to expand by over 15 percent, signalling insatiable cash demand in the system. As a result, the overnight call rate now exceeds 6.7 percent, which is almost 25-27 bps over the policy rate itself.
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