The Reserve Bank of India’s (RBI) efforts to tighten the availability of rupees in the market and abrupt a slide in the currency may squeeze profitability at the nation’s lenders as it raises their funding costs, according to the local unit of Moody’s Investors Service.
The rupee, Asia’s worst-performing currency this year, hit a record low on Thursday with rising oil prices threatening to stoke inflation and worsening government finances. State-run banks probably sold dollars on behalf of the RBI to arrest these declines, local traders said. Creating a shortage of the local currency risks worsening liquidity in India’s banking system, which is already running short of cash.
“Liquidity is already tight in the system and any efforts by RBI to strengthen the local currency will suck that out and squeeze banks further,” said Karthik Srinivasan, group head of financial sector ratings at ICRA Ltd., the local unit of Moody’s. “A profit pinch will be felt and lenders with a higher portion of funding coming from bulk deposits and debt will be affected the most.”
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Indian lenders can hardly afford another headwind as they absorb trading losses from the past year’s drop in sovereign bonds and continue to battle one of the world’s worst bad-loan ratios. The country’s largest banks including State Bank of India and ICICI Bank raised lending rates earlier this month given a combination of weak deposit growth and the strongest loan demand in four years.
Liquidity in the financial system is currently at a deficit of around Rs 215.7 billion, according to the Bloomberg Economics India Banking Liquidity Index, having moved from a surplus of Rs 5.5 trillion in March 2017. Advance tax outflows in the second half of June sparked the cash crunch.
According to ICRA, banks that have large investments in corporate bonds will see a further erosion in profits if yields surge following measures by the RBI to curtail currency volatility.
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