The hawkish monetary policy affirmed a new normal in financial intermediation.
Higher input costs imposes risks to businesses and banks. RBI’s 6.7 per cent inflation projection for FY23 shows that inflation will be at an elevated level for the next three quarters.
RBI had to also change the accommodative stance to manage inflation and raised policy rates aggressively.
Despite the growth risks of policy rate hikes, Indian economy is not in danger of falling into stagflation like western economies.
The RBI Surveys have provided some positive signs of steadiness in rural and urban demand. Besides the high frequency indicators, the contactless industry is also witnessing signs of growth. The monsoon is also expected to be normal.
Banks now need to price their assets and liabilities in sync with RBI’s actions.
Borrowers are in a state of uncertainty in assessing their cost of borrowings. Banks may not be able to hike lending rates, so synchronised risk management by banks will be essential.
FPIs’ exit from Indian markets is putting pressure on the rupee. Despite RBI’s intervention, banks will have to be alert in taking position and hedging forex risk exposures.
Thanks to rising interest rates, banks will need to protect their net interest margin (NIM) by balancing pricing of loans and risk premium.
In balancing these factors, banks will be exposed to interest rate risk. Large ticket depositors/borrowers will be interest rate sensitive posing business risks to banks.
Interest rates have been raised by many banks after the recent policy rate hikes. Even interest rates on high value savings bank segments have been hiked to protect flight of it to term deposit segment, effectively raising cost of deposits to banks.
The highest interest on term deposit of SBI is pegged at 5.5 per cent, HDFC is 5.6 per cent, Canara Bank 5.75 per cent PNB is 5.25 and IDFC Bank, 6.25 per cent. The interest rate differential ranges from 10 basis points to as high as 75 basis points. Their corresponding 3-year Marginal Cost of Funds Based Lending Rate (MCLR) is 7.3, 7.4, 7.35, 7.6 and 9.2 per cent respectively of these banks.
The differentiated pricing policies and loading of risk premium strategies could trigger transfer of businesses from one bank to another shifting risks depending upon the ticket size of business volumes.
Banks may need to rework their risk strategies as businesses hit by high input costs will be under pressure to service their loans.
Compared to profitability of recent years, it will prove difficult for banks to maintain a balance between cost of resources and risk adjusted yield on resources when even regulatory costs are rising.
The recent 50 bps CRR hike will deprive banks from earning on additional funds impounded by RBI.
When about 40 per cent of loans are linked to external benchmark, they will get repriced with repo rates going up calling for hike in term deposit rates exerting pressure on incremental revenue generation for banks. Banks will have to work to augment deposits with cost efficiency by aligning deposit rates to fund the new loans. The EMIs will also go up increasing threat to the asset quality.
Hence managing interest rate risks will call for particular focus to protect the risk adjusted margins factoring asset quality risks. It is a testing time for banks to manage multiple risks whose shape, dimensions and impact on balance sheet is dynamic and difficult to estimate.
More so, when the constituents of banks are equally operating on risky turf, apprehending and managing transmission risks calls for greater prudence.
The writer is Adjunct Professor, Institute of Insurance and Risk Management – IIRM. Views expressed are personal