According to the SBI’s economic research report Ecowrap, banks are encountering notable margin pressures despite the surplus of liquidity in the banking system. A back of envelope estimate by SBI’s economic research department recommends that the core funding cost of the banking system that includes the cost of deposits, negative carry on Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR), and Return on Assets is currently at 6 percent, whereas the reverse repo rate is at 3.35 percent. According to the report, if the cost of provisions is added to the core funding cost, the total cost comes to almost 12 percent.

 

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According to Soumya Kanti Ghosh, Group Chief Economic Adviser, SBI, banks are encountering significant margin pressures. This apart, according to the market sources risk premia over and above core funding cost are not fairly acknowledging the inherent credit risk. The report stated that the problem of low credit demand and excess liquidity is apparent from the average reverse repo at ₹7 lakh crore since April and Government of India cash balances with RBI at ₹3.4 lakh crore. The report mentioned the example of 15 years loans, which are being priced at even lower than 6 percent, linking with repo/treasury bill rates, stressing that 10-year Government Security (G-Sec) is currently trading at 6.2 percent and by the current pricing trends this may further approach towards 6 percent again. Ghosh told that this anomaly apart from negating the concept of the tenor premium may also create a material risk concerning the sustainability of such rates in long term, about which borrowers and banks are basing their financial calculations. The good thing about it is that such a pricing war is mostly restricted to AAA borrowers. According to the report, three-year term loans are being quoted at close to a 4 percent repo rate, and seven-year term loans for borrowers below AAA are also quoting a risk premium of 15-20 basis points over the 10-year rates. Working Capital Loans (WCL) are currently being quoted at a notch above the reverse repo rate at 3.35 percent. Relating to RBI introducing the concept of normally permitted lending limit (NPLL) for specified borrowers, as to push them to go towards the corporate bonds market. In the current situation, corporate bond rate and bank lending rate are showing huge differential. Gosh noted that the commercial paper (CP) market is seeing notable churn with banks now almost absent. Non-Banking participants like MFs who don't have access to the RBI Reverse Repo window are producing pricing pressure in the CP market as they are sometimes quoting below RBI reverse repo rate. He stated that the CP market shows a huge pricing gap between better and lower-rated borrowers.

The report underlined that the industry is substituting its long-term debts with very low-priced CP/working capital demand loan (ECDL) and this will act as an enabler once the investment cycle revives. Nevertheless, there is the risk of an asset-liability mismatch if the liquidity is withdrawn promptly. According to Ghosh, as of now, the inflation numbers may not warrant such a decision from RBI, but in case of core inflation persists in the current range of 6 percent or above, it may act as a barrier to the continued liquidity abundance.

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