PSBs can tide over ALM issues with long-term bonds: India Rating

Says rise in ALMs in state-run banks is due to the growing divergence in the tenors of loans and deposits

Issuing senior long-term bonds may help public sector banks correct their asset liability mismatches and also improve liquidity coverage ratio, says a report by rating agency India Rating.

"Permitting state-run banks to issue senior long-term bonds will help correct asset-liability mismatches (ALM) and provide a tool to improve liquidity coverage ratio by extending funding outflows," India Ratings said in a report today.

It also said the rise in ALMs in state-run banks is due to the growing divergence in the tenors of loans and deposits.

For the state-run banks, the cumulative negative funding gap up to one year has increased to 15.7% of assets as at end-March 2014 from below 4% in 2002.

For some banks, there is even a shortage of ready collateral that could be used to repo with the Reserve Bank in a liquidity squeeze, the report said.

The rating agency believes that the trend of rising funding gaps in the banking system is unsustainable, particularly as an economic revival may require continued bank funding for longer tenor infrastructure loans.

Senior bonds are rated at the same level as banks' long-term issuer rating in the absence of a bank resolution regime and are not treated like loss-absorbing hybrid capital, the report said.

State-run banks have easy access to long-term investors such as insurance and pension funds and hence are well placed to tap this market, the report said.

The existing guideline that permits banks to issue 'infrastructure bonds' has not found favour with investors, perhaps due to the implicit link with a sector that has been struggling to perform for some time.

Senior bonds issued globally by domestic banks have a good investor base. A similar (and possibly larger) market can be created among domestic investors, the report said.

It further said the banking system's dependence on short-term liabilities has grown to a point where refinancing pressures are hurting margins.

"This also poses unique policy challenges, including diluted monetary transmission, a persistently flat-to-inverted yield curve and crowding out corporates from the commercial paper market," the report said.

Deposits maturing within one year increased to almost 50% of total deposits in 2014, up from 33% in 2002. The ratio had dipped in 2013 after growth in advances had moderated, before rising in 2014, it said.

A significant portion of these deposits had maturities within six months and, for some banks, included a growing share of wholesale money market borrowings.