Commercial lenders in India are heavily exposed to sovereign debt as they are required by the central bank to invest 24 percent of their core deposits in government bonds. A downgrade of India’s credit rating to below investment grade would therefore have a knock-on effect for local banks.
“There are two ways a (sovereign) downgrade would impact the banking sector. As (government bond) prices go down, this impacts the capital base of banks. Secondly, the banks’ cost of funding goes up,” said Anita Yadav, managing director at the corporate bond brokerage and asset management firm SJ Seymour Group.
To an extent, Indian banks are protected from rising costs of funding because 70 to 80 percent of their funds come from domestic deposits. But a change in funding costs would still affect the profitability of banks as foreign investors account for 10 percent of their liabilities, according to Fitch.
“On the external funding side, pricing would increase but it’s not significant because external funding is under 10 percent of total liabilities,” Bhoumik said.
While Yadav agrees that a downgrade would not threaten the financial position of the lenders, she points out that a downgrade would limit banks’ ability to tap overseas investors for funds.
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