Volume : 11, Issue : 4, APR 2025

LIQUIDITY AND PROFITABILITY DYNAMICS UNDER BASEL III: EVIDENCE FROM SELECTED INDIAN BANKS

NIRMAL KUMAR CHHIMPA, DR. SWATI CHOUDHARY

Abstract

This research examines the interplay between liquidity and profitability in selected Indian banks under the Basel III regulatory framework, implemented to enhance banking stability post the 2008 financial crisis. Basel III presented stringent liquidity necessities, such as the “Liquidity Coverage Ratio” (LCR) and “Net Stable Funding Ratio” (NSFR), alongside higher capital adequacy norms, which have significantly influenced banks’ operational dynamics. The study analyzes data from 10 major Indian banks (5 public and 5 private) over the period 2010–2023, using dynamic panel data regression techniques to assess the impact of liquidity compliance on profitability metrics like “Return on Assets” (ROA) and “Net Interest Margin” (NIM). Findings reveal that while adherence to LCR reduces liquidity risk, it negatively affects NIM due to increased funding costs from holding high-quality liquid assets (HQLA). Public sector banks exhibit greater resilience in maintaining profitability under liquidity constraints compared to private banks, attributed to their deposit base stability. However, higher LCR compliance correlates with increased non-performing assets (NPAs), straining profitability. The study reveals a crucial trade-off: while stronger liquidity reserves enhance financial stability, they also tend to compress profit margins, especially among private sector banks that depend heavily on narrow interest spreads. Additionally, macroeconomic variables such as GDP growth and inflation significantly affect the relationship between liquidity and profitability, with inflation particularly driving up funding costs. The research emphasizes the importance of designing customized liquidity management strategies that align regulatory requirements with profitability objectives. It further suggests that policymakers should account for the distinct characteristics of individual banks when adjusting Basel III regulations to avoid unintended negative effects on bank performance in India. By offering empirical findings from an emerging market setting, this study adds valuable insights for regulators and banking professionals addressing the complexities of Basel III implementation.

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