Jan 2015 LCR goal now achievable, but meeting the 2019 target will need support from corporate bond market
The Basel-III guidelines on LCR are aimed at building banks' resilience to disruptions in systemic liquidity. They require banks to hold sufficient high-quality liquid assets (HQLA) to cover potential cash outflows (net of inflows) in a stress scenario lasting 30 days. HQLAs consist of government securities, highly rated corporate bonds, and commercial paper. The revision announced in the September monetary policy review, allows banks to include a higher share (7 per cent of net demand and time liabilities, up from 2 per cent earlier) of their government security holdings under statutory liquidity requirements (SLR) as a part of HQLA. Detailed guidelines around operationalising the liquidity facility and clarity on aspects such as mark-to-market requirement and cost of facility are expected in November 2014.
As per the initial guidelines, an estimated Rs.6.6 trillion of government securities (including Rs.4.8 trillion of excess SLR) qualified as HQLA for the banking system. This was not sufficient for most banks to meet their LCR targets. Says Mr. Pawan Agrawal, Senior Director, CRISIL Ratings, “The revised norms allocate a greater share of bank investments in mandatory SLR towards HQLA. This will enhance the quantum of HQLA by an additional Rs.4.5 trillion for the entire system. This should help most banks to comfortably meet their near-term LCR requirement of 60 percent by January 1, 2015.”
As for attaining 100 per cent LCR by January 1, 2019, banks face three main challenges. First is that a majority of banks advances - such as cash-credit facilities, which account for 45 per cent of total advances - do not qualify for inclusion as inflows in a stressed situation because their tenures are not fixed. Second, banks have substantial deposits from financial institutions and corporates (nearly 25 per cent of total deposits). A large portion of these are considered outflows in a stressed situation. Third, bonds and commercial paper issued by financial sector entities, which form 70 per cent of India's annual capital market issuances, cannot be included in HQLA.
While a phased reduction in SLR from the current level of 22 per cent would help partly offset these challenges, a deepening of India's corporate bond market is also critical. Says Mr. Rajat Bahl, Director, CRISIL Ratings, “We estimate that less than 10 per cent of banks' HQLA is in the form of non-financial corporate bonds and commercial paper, as against the permissible 40 per cent. A deepening of the corporate bond market over the medium term will allow for more issuances from the corporate sector, and enable banks to meet their LCR requirements.”
