Banks may not be pricing their risks adequately, says new report from SBI Research

rbi, banks, risk, liquidity, tenor premium

RBI‘s policy of providing abundant liquidity may have resulted in banks inappropriately pricing their lending risks, according to a report by SBI’s research team.

“A back of envelope estimate suggests that the core funding cost of the banking system that includes cost of deposits, negative carry on SLR and CRR and Return on Assets is currently at 6%, while the reverse repo rate is at 3.35%.”

Additionally, if we add cost of provisions to the core funding cost, the total cost comes to around 12%. Clearly, banks are facing significant margin pressures” said the research report.

Besides, market analysts point that risk premia over and above core funding cost are not fairly acknowledging the inherent credit risk. For example, 15 years loans are being priced at even lower than 6%, linking with Repo / T-Bill rates. At the same times 10- year government bond is currently trading at 6.2% and by the current pricing trends this could even gravitate towards 6.0% again. ” This anomaly not only negates the concept of Tenor Premium but may create a material risk with regards to sustainability of such rates in long term, on which borrowers and banks are basing their financial calculations” the report said.

The economists at the country’s largest lender feel that it is now the opportune time to revisit the taxation of interest on bank deposits, or at least increasing the threshold of exemption for senior citizens. “The RBI can also relook at the regulation that does not allow interest rates of bank to be determined as per age-wise demographics. Additionally, while there is no restriction by RBI on benchmarking of loans (as against earlier MCLR) and Banks are free to use any benchmark published by FBIL, continued restrictions on not allowing negative spread on MCLR may also be removed” noted the repoty.” This will help Banks to be nimble, optimally manage and book quality business without having to expose the entire book to external benchmarks”.

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