Trouble ahead? Top bank borrows Rs1,000 cr @ 20%

A large Indian commercial bank borrowed Rs1,000 crore from another major domestic bank at more than 20% interest rate earlier this week, a desperate move that underscores the gravity of the liquidity scarcity for some Indian banks, notwithstanding assurances to the contrary by regulators and politicians alike.
The short-term money was raised through certificates of deposits, or CDs, essentially a promissory note that bears a maturity date and a specified fixed interest rate.




It appears that this is the highest interest rate charged by any Indian bank on a 45-day loan given to another bank since the mid-1990s, when liquidity was scarce and interest rates soared, following a tight monetary policy by the central bank against what was then a backdrop of rising inflation.
This time around, the root of the problem is global liquidity crunch and banks’ sudden and growing aversion to lend to each other as the general confidence level in the banking system has declined sharply in the past one month.
Banker’s Trust is unable to name the banks involved because that was a precondition to confirming details of this sensitive transaction.
While the structural stability of the Indian banking system hasn’t come in question in the global meltdown that has already taken down several banks, even Indian banks that can afford to lend now don’t want be stuck just in case there is another bank collapse and would rather keep as much cash as possible in case they, too, have to deal with any large withdrawals by depositors, especially companies and funds.
The good news is Indian banks can still find money within their ranks, unlike those in the US and UKIn this particular case, the borrower of the money was desperately looking for funds to tide over short-term asset-liability mismatches in its overseas operations. Most of the large Indian banks, both state-run as well as private ones, have overseas presence. The aggressive ones have been building assets overseas by rolling over their liabilities, raised from the inter-bank market.




But these money lines are now fast drying up and it is difficult to replenish them as overseas banks are not rolling over the credit any more even though the London interbank offered rate, or Libor, an international benchmark for interest rate, is soaring. Libor is now much higher than the yield on three-month US treasury bill, and this illustrates the risk perception of financial institutions about each other. If they have money, they would lend to the US government and not to a fellow institution.
So, if an Indian bank faces a liquidity crunch abroad, it is now being forced to borrow from India, convert the money into foreign currency, and then quickly export the funds to support the bank’s overseas operations.