Liquidity imbalance - A pragmatic strategy

Category - Corporate Banking Advisory (ACG)

The article intends to explore a financial instrument which could address the current impasse in the banking sector as a sequel to slide in long term deposit as against estimated credit growth. The imbalance calls for building up assets in the short term and liabilities in the long term by developing a multidisciplinary model for a comprehensive solution.

Key Words: ALM, Collateral, Self liquidating, Contingency, Discounting,Structured finance,Credit Culture, Accountability, Import substitution, Asset liability Management, capital adequacy, conversion factor

Sourcing of funds

The plausible sovereign concern for shortfall in resources in the wake of forthcoming credit growth calls for innovative resource generating schemes in order to match the ALM gap. The banks with spread of branches all over the country are expected to play a pivotal role in garnering deposits, the bulk of which shifted to alternative investments. Generally the cost of funds in such deposits are less than the cost of raising funds from alternative avenues. While the banks are likely to target senior citizens for raising deposits by offering higher rates of interest or by evolving innovative schemes, the effectiveness of such a drive remains uncertain.

It is imperative that the primary reason which raised the concern of regulators be examined in order to develop a model for a strategic solution to the forthcoming liquidity concern in medium to long term.Generally majority of retired / elderly people preferred to create fixed deposit for long term to maintain their livlihood without diluting the principal as well as to secure their future against any eventuality. In recent years the market rate of term deposits started sliding, which caused a liquidity shortage for those depositors. On the other hand, return on investment in capital market/ mutual funds continued to offer better returns as compared to the bank deposits. SEBI intervention facilitated improvement in the quality of investment as well as flexibility improved. The invested amount in mutual funds can be converted to liquidity immediately, which was erstwhile time consuming. As a consequence the banks started losing long term fixed deposits , which is a prerequisite for term lending at a reasonable rate. Banks started resorting to alternative sources including borrowing from RBI, where average cost is higher.

A close introspection may reveal that the source of deposits are not exclusively individual depositors but also contributed by the corporate segments by way of margin money etc perked in the bank against non-fund based limits as well as other float funds on transactions. Inertia in sanctioning of credit facilities to small, Medium and large industries resulted in stunted growth of credit in industry and trade segments, which has a spiralling effect on the deposit growth. In order to address the factor responsible for the present shortfall in deposit and thereby mismatch in long term , it is essential to examine the reasons for slow down in credit sanctions in industry and trading sector , specially MSME segment as compared to the credit off take in retail segment.

As per the data released by RBI in the fortnight ended March 22, 2025 as against Fortnight ended March 21, 2024

Sectoral deployment of credit in scheduled commercial banks:

Sector	Change in 22.03.2025 against 21.03.24 over last year	Change in 19/09/25 against 20.09.24 over last year status	STATUS
Agriculture & Allied	10.4% against 20% last year	9% against 16% last year	Negative
Industry	8% against same rate last year	7.3% against 8.9% last year	Negative
Service	13.4% against 20.8% last year	10.2% against 13.7 % last	Negative
Personal Loan	14% against 17.6% last year	11.7% against 13.4% last year	Negative

As evident from the aforesaid data released by RBI, credit growth is steadily declining. As

observed from the data released by RBI on Trends & progress of Banking in India 2023-24

while the YoY demand deposit was nearly at the same level, term deposit shows a decline of 10.8% (even after interest accrued on term deposit was added), which indicates that the real slide is considerably higher. YoY on year growth of bank credit came down to10.6% as against 20.7% during previous year. As such ,after considering the interest component the real increase was marginal.Fall in non-food credit was 39% as against rise in food credit from (-)Rs 9927 cr to Rs 9561 cr. In terms of volume, bank credit had fallen from Rs 2719212 cr to Rs1683715 cr exhibiting a deceleration of Rs 1035497 cr. Aggregate deposit reduced by Rs 48006 cr.Shortfall was covered by borrowing. The position reveals that unless remedial measures are taken, the increase in cost of funds is likely to adversely affect the profitability of the banks.

Credit Deployment

Credit decision makers, in apprehension of accountability , remained reluctant to exercise their discretion in decision making specially in green field projects. The manifestation of risk averseness of the credit decision makers was visible as banks shifted towards safer avenues i.e retail loans etc.The downward trend in industry sector also influenced the consumer loan sector, since individual borrowing is largely dependent on the growth of industry & trade. The unwillingness of the credit decision makers was recognised by the government as well as the regulator and measures were taken to dispel the apprehension by announcing certain measures. The intent of the regulator was in the right direction but the implementation of the guidelines failed to evoke desired response. Credit decision makers continue to become risk averse and insist on high collateral for offering credit to mid corporate and also large corporate segments.

The collateral requirement came to 30-50% or even higher , which constrains entrepreneurs to invest in their new ventures. Wherever obligors agree to the request, there are aberrations in compliance of “conditions subsequent” in view of the fact that bulk of their resources are blocked for offering stipulated collateral. Stability in the financial sector requires an urgent solution to the problem in order to accelerate the long term deposit growth as well as increase credit to the Large Corporate / MSME/ Export/Import segment.

An Introspection

By a close examination of the deposit structure , it would reveal that bulk of term deposit is sourced from senior citizens and they are relying on the bank for regular revenue earning periodically from the term deposits. Slides in the rate of interest adversely affected their earnings and they started resorting to mutual funds and other alternative investments. It is unlikely that the flight of deposit could be arrested unless their exclusive needs are addressed. A senior citizen is more concerned about medical requirements and spends a significant portion of their income towards medicine and medical accessories. On the other hand , Insurance companies, as a part of their risk mitigation strategy , tend to reduce their exposure to aged people. There are ceilings beyond which the insurance holder has to arrange for funds, Domiciliary treatments are generally not included or added with a higher price.Any model towards resolving the current conflict should address the medical problems of senior citizens, especially when children of the senior citizens are staying in distant places and cannot attend to their parents instantly. Insurance companies are generally risk averse and their premiums accelerate along with the increase in age. Further, there are items which are necessary at old age but insurance cover exclude those items while settling the claims e.g certain consumables which are essential. They also tend to decline new requests after a certain age i.e 60 plus.

The interest income on deposits maintained by the senior citizens in banks serves the purpose of both revenue generation for day to day expenses ,as well as cushion against future eventualities, primarily medical. In many cases children are working in distant places and they rely on the funds in banks. It may be observed that savings balances maintained by such elderly persons are generally high, although the return is much less. The funds deposited in savings accounts serve as contingency against future exigency during the period of hospitalization and arrival of the children from their place of work. As such any strategy to resolve the current impasse should integrate all these aspects and address specific needs of the individuals.

Risk Factors

The objective of ALM is to develop strategic solutions based on identification of the gaps . Any resolution to the present constraint should consider resource management as well as asset creation. In the liability side of the ALM statement there are CASA and float funds in the short term , while the asset side in the short term consists of cash credit, bill discounting etc. It is observed that the liability side exceeds the asset side in the short term, while the asset side ( which consists of term loan , investment etc ) far exceeds the liability side in the long term. It may be mentioned here that while ALM gap considers the core portion of the float funds/ CASA as long term liability based on the trend .The short fall of liability is primarily due to flight of term deposits from the banks. The present gap clearly calls for adequate strategy in order to create stability in the financial sector.

It would be prudent to refer to the risk management guidelines for a probable solution. The

regulatory guidelines based on the basle committee prescriptions assign separate risk factors based on the credit facilities. There are credit conversion factors for non fund facilities ,which are considered low risk facilities( ref. RBI master circulars on capital adequacy). Sanction of non fund based facilities are closely related to sanction of credit facilities to large/ medium segment manufacturers/traders/exports/imports.

Capital adequacy plays a crucial role in credit decision making by banks. As per the guidelines of RBI, Financial guarantees attract a higher capital adequacy as compared to non financial guarantee. Further, Letter of credit (short term self liquidating trade related contingency) attracts much lower capital adequacy, i.e conversion factor is 20%. A strategy to correct the present mismatch should consider these factors for creating an instrument which can eliminate the risk factors in credit dispensation.

Any instrument which can arrest the flight of deposit from banks should consider :

• Medical requirements beyond the scope of mediclaim.

• Can be honoured by hospitals/ Medical service providers, without initial payment by the patient.

• Can bridge the time period between the hospitalization and arrival of close relatives located in distant places,

• Cover expenses for a period required for generating the fund post diagnosis of the disease.

• Available instantly i.e presanctioned facility

A Plausible Remedy

Credit Facility by way of “short term self liquidating trade related contingency” (TRSLC) e.g Letter of Credit refers to a pre-sanctioned contingent facility backed by cash flow/ tangible securities which is secured, self liquidating and trade related. A common example is Letter of Credit . A letter of credit is a pre-sanctioned contingent facility which empowers the beneficiary to provide service and claim funds instantly. The bank issuing the LC provides funds and claims within the period stipulated from the obligor within a specific time period. In case of Usance LC the period may generally be 90 days, which can be extended based on the credit quality.

Sanction process

In case of depositors ,more specially elderly persons, fixed deposits in the bank generate interest income as well as being considered as security for sanction of credit facilities. A general practice of contingent funds maintained in savings accounts can be replaced by investment in term deposits. The term deposit can be offered to the bank for issue of a “short term self liquidating trade related contingency” with a usance of say, 90 days. On the basis of request of the depositor, the bank can sanction a facility of say, letter of credit with a usance of 90 days against the fixed deposit with a margin of say10%. Based on the prior arrangement with hospitals, the patient may approach the hospital for admission. The banker of the hospital will discount the instrument (e.g LC) and provide funds to the hospital/medical service provider, and in turn claim the fund from the LC issuing bank. In such cases the LC issuing banker is protected by the FDR and can recover the fund from the FDR in case of delay/default in payment.

The fund available against LC will cover:

• Own contribution of the patient , in case of mediclaim/ cover the fund requirement of the medical service provider during the initial time period .

• Covers the fund requirement which is outside the scope of the mediclaim such as additional expenses payable for cabin, consumables not covered by mediclaim etc.

• Cost incurred in hospital during the period of arrival of close relatives from distant places

• In case of emergency the hospital can start the process of laboratory testing etc without deposit of any funds by the patient.

As it transpires, the facility bridges the needs of the two sides, i.e provide incentive to the depositor ( thereby bank) to deposit funds for a longer period and even in case of slides in rate of interest the depositor will feel safe that the instrument ( say LC) can provide comfort to the hospital on the availability of funds during the critical period/ diagnosis and admission. Unlike credit cards the facility will not attract any interest unless there are drawals against the LC issued by the bank and LC issue charge is insignificant as compared to fund based credit limits.

The LC can facilitate availability of services without paying its own fund and can replenish the fund within a period of say 90 days, by depositing their disposable income in a dedicated fund. While term deposits will become attractive because of the additional facility, there can be a build up of funds by the depositor in order to meet the commitment at the time of maturity of the LC. Such practice can be inculcated among depositors, which will improve the deposit base of the banks. Gradually such facilities can be extended towards non medical services also.

Credit Marketing Perspective

One aspect which concerns the regulator is the slow down of lending decisions in apprehension of accountability . The aforesaid credit exposures will be treated as structured finance without assuming any risk of default. With proper marketing of the product and build up of awareness in the market credit culture is expected to improve. Gradually financial collateral can be replaced by physical collateral by way of mortgage of fixed assets to sanction credit limit for sanction of (TRSLC). It is imperative that the facility can be facilitated by issuing a credit card-like instrument which will be acceptable to the medical service providers without paper work. Such instruments can be extended to MSME and small business segments for meeting immediate financial needs. Gradual acceptance of the product will dispel the apprehension about accountability and credit decision makers will be encouraged to exercise their discretion. The drive will ignite innovations for extending credit to first time entrepreneurs as well as extend support to small business segments along with growth of term deposits. The facility will supplement the insurance sector because the depositors will utilise the fund received for funding of the expenses which are not covered by health insurance and also procuring medical accessories and medicines.

Resolving current impasse

The volatility in global economics post tariff war , which has affected large no of exporters dependent on export to the USA ,prompted an introspection of the policy framed by the regulators. The sovereign call for emphasis for import substitution requires concentration on the growth of the domestic MSME segment as well as generation of long term resources in order to avoid cost of borrowing. The proposed model is likely to support both liability and asset side and bring about a balance in asset Liability management for better strategic management . Further the proposed instruments could be effective in supplementing insurance segments in creating coverage for those risks which are not normally considered by insurance companies, i.e mediclaim for elderly people, expenses which are not reimbursed by insurance companies during hospitalisation, etc. Considering the future perspective, the facility will attract deposits in the bank irrespective of the volatility in interest rate and strengthen the process of credit decision making and improve credit culture. The proposed instrument will be complementary to the mediclaim facility provided by the insurance sector and banks enter into a mutually beneficial agreement to

promote the product with the insurance sector.