Last week, the RBI announced steps to tighten liquidity and address exchange-rate volatility after the rupee fell to a historic low. Money markets reacted by dramatically raising rates in the interbank market and yields on government bonds.
"These measures are credit-negative for Indian banks because rising market rates will negatively affect economic growth if they persist, putting negative pressure on asset quality and earnings," Moody's said in a statement.
In addition, it said, bank funding costs will rise if higher rates persist. The Reserve Bank's measures, announced on July 15, included increasing lending rates for banks and draining Rs 12,000 crore through open market operations. The rupee dropped to a record low of 61.21 to a dollar on July 8.
These measures seek to support the exchange rate and discourage currency speculation by reducing short-term liquidity and soaking up excess liquidity, Moody's said.
However, it said, there is a risk that the period of tight money market liquidity in India may persist, which would eventually have a material negative effect on bank funding. "We expect banks to be negatively affected if higher rates persist for one or two months," the rating agency said.
In particular, Moody's said, banks that rely more on wholesale funding, such as Yes Bank and IDBI Bank Ltd, will be more vulnerable because their margins would suffer if they fail to pass on higher costs to borrowers.
More generally, the RBI's measures add to the challenges already affecting the economy and which will impact banks' operating environment. "We note that market reactions to the RBI's announcement have been dramatic, with market interest rates rising across all maturities despite the RBI's measures only targeting short-term rates," it said.


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