Over the past few months, deposit growth has lagged credit growth by 3-4 percentage points. According to the latest RBI data, as of 26 July, bank loans surged 13.7 per cent year-on-year, while deposits only grew by 10.6 per cent. If this mismatch continues, the banking system could face a serious liquidity crunch, which is why, taking a cue, Shaktikanta Das, governor, the Reserve Bank of India (RBI), India’s apex banker, openly raised concerns about the slower deposit mobilisation compared to credit growth, saying that it may create structural liquidity issues.

Das asked banks to maintain a reasonable balance between credit and deposit growth. “The deposit mobilisation has been lagging credit growth for some time now,” he said at the BFSI Summit 2024. “This may potentially expose the system to structural liquidity issues.”

Soon enough, Finance Minister Nirmala Sitharaman also called a meeting with public sector lenders, urging them to boost deposit growth. She said that banks needed to take the old-fashioned route to bring back focus on mobilising small deposits and not just big deposits to reverse the flagging deposit growth rate.

Some experts argue that the good thing is credit growth has not been impacted and the real problem would only arise if the banks get constrained to lend due to slower deposit mobilization. At present, there seems to be no stress on the credit growth, as banks have various other means to raise funds, apart from deposits, as and when the need arises.

Overall advances of State Bank of India, the largest PSU bank, rose 15 per cent year-on-year (y-o-y) to Rs38.12 lakh crore in Q1 2024-25, while total deposits were up 8 per cent y-o-y at Rs49.01 lakh crore.

Statistical myth?

According to a CareEdge report by CARE Ratings, SCBs in India have seen a significant 19.3 per cent year-on-year credit growth in the last quarter of 2023-24, translating into an expansion of Rs26.6 lakh crore, reaching Rs164.3 lakh crore in total credit. However, deposit growth lagged at 13.6 per cent, with the CDR rising to 79.7 per cent. The latest data from RBI for the fortnight that ended 9 August showed that bank credit growth continued to outpace deposit growth – with advances rising 14 per cent and deposits growing by 11 per cent.

One of SBI’s research reports released last month says that flagging deposit growth appears to be a ‘statistical myth’, with the credit growth’s outpacing of deposit growth being tom-tommed as a deceleration in deposit growth. It also pointed out that incremental deposit growth at Rs61 lakh crore has exceeded incremental credit growth of Rs59 lakh crore since 2021-22.

According to Janak Raj, former executive director, Reserve Bank of India & senior fellow, Centre for Social and Economic Progress, the root of CD mismatch is the savings rate. Before the current tightening of the monetary policy began in May 2022, the credit growth of scheduled commercial banks was 11.2 per cent year-on-year as of 22 April 2022, while the deposit growth was 9.8 per cent and the incremental CD ratio, 80 per cent, affirms Janak Raj, in one of his articles.

By 8 February 2023, the RBI had raised the policy repo rate by 250 basis points (bps). However, there was little evidence of monetary transmission, as credit growth accelerated to 15.4 per cent by end-May 2023, whereas deposit growth picked up only marginally to 11.8 per cent. Consequently, the incremental CD ratio surged to 94 per cent. The situation worsened further by 9 August 2024, when the incremental CD ratio rose further to 98 per cent, driven by robust credit growth at 15 per cent, even as deposit growth moderated at 11.3 per cent.

According to Janak Raj, while interest rates by SCBs were raised by 1-1.9 per cent on term deposits of different maturities during the current monetary tightening cycle, interest rates on savings bank deposits by major banks were left untouched at 2.7-3 per cent, which needs to be put in perspective.

So, is there a matter of concern for the banking industry? While opinions from banking experts vary, largely they feel that things are within manageable limits. A recent research note by Motilal Oswal Financial Services said: “The high loan-deposit (LD) ratio of the Indian banking system at 77.2 per cent as of 9 August is not a matter of concern, since there is no tightness in the banking sector as exhibited by an average Liquidity Adjustment Facility (LAF) deficit of 0.3 per cent of net demand and time liabilities and a stable weighted average of call rate (WACR).

As the Indian economy continues to evolve, the banking sector must adapt and innovate to secure its stability and foster sustainable growth. The growing disparity between deposit growth and credit growth in public sector banks is a multifaceted challenge that requires immediate attention. Addressing this issue will necessitate a concerted effort from banks, regulators and policymakers. Strategies could include enhancing the attractiveness of deposit products, leveraging technology to improve customer engagement and reassessing interest rate policies to ensure that banks can maintain a healthy balance between deposits and lending.

Where did the money go?

So, why have the deposits steadily declined? Where are people parking money? It is no secret that, driven by a young workforce, people are now preferring to park their investments in other lucrative sectors. The rapidly burgeoning kitty of mutual funds (MF) shows that it has emerged as the preferred choice. The Covid-19 pandemic saw a major shift, with the Indian capital markets seeing a surge in retail activity through direct (direct trading) and indirect (using the mutual fund route) channels.

The latest data from the Association of Mutual Funds in India (AMFI), the industry body of the asset management companies (AMCs) of all mutual funds in India, shows that the MF industry has reached a new assets under management (AUM) milestone of Rs66.70 lakh crore in August 2024.

Another interesting fact the AMFI data showed was that the total folio count of the MF industry grew to an all-time high of 204.5 million. In addition, the monthly gross inflows through SIP reached Rs23,547 crore. In July, the MF industry had 198.4 million folios. With equity funds in higher demand, the MF industry saw net inflows in equity funds for 42 consecutive months, which increased to Rs38,200 crore in August 2024 – up from Rs37,100 crore in July 2024.

Apart from MFs, the investors prefer to park their money in direct equity investments too. According to the Economic Survey 2023-24, the number of demat accounts with both depositories National Securities Depository Ltd (NSDL) and Central Depository Services Ltd (CDSL) rose from 114.5 million in 2022-23 to 151.4 million in 2023-24.

At the same time, the investors on both the leading exchanges are growing at a fast rate – while the registered investors on the BSE, as of 15 July 2024, stood at 181.1 million, the NSE-registered investors have surpassed 190 million, with the latest one crore additions taking place in just five months.

Clearly, the money is flowing out of the banking system into the MF sector and direct equity segments at the cost of bank deposits. A report by the Bank of Baroda (BoB), How serious a threat are mutual funds to bank deposits?, published in September 2023, highlighted the shift in investor preference towards mutual funds, with a y-o-y growth of 18.6 per cent, compared to 12.3 per cent for bank deposits, which explains the RBI concern about banks efforts to attract deposits.

According to a recent research report by Punjab National Bank, authored by its chief economist Deepak Singh and economic officer Smriti Behl, in the last decade, households have also diversified their holdings of gross financial savings. “Deposits, which accounted for 58 per cent of their savings in 2011-12, now stood at 37 per cent in 2022-23. While household savings channelled in shares and debentures have increased, their share although is still in single digits,” the report said.

V.K. Vijayakumar, chief investment strategist, Geojit Financial Services, also concurs with the facts. The consequence of the larger shift in the behaviour of the younger generation, from savers to investors, is why the apex bank is concerned, he says.

Rate wars

Now, will there be a rate war between banks to attract deposits? The big question is: with the central bank and the government intermittently flagging the issue of CDR and LDR, will the banks compete with each other for a larger pie of the deposits and, in that melee, will we see a rate war? However, most bankers do not agree.

“Though competition for deposits among banks is likely to continue for some time, instead of getting into a rate war to mobilise deposits, our bank would focus more on improving service quality,” says Challa Sreenivasulu Setty, chairman, State Bank of India. Speaking at the ‘Global Fintech Fest’, Setty conceded: “However, there will be some tweaking in interest rates in the 1-2-year bucket, which is the most popular.”

According to Setty, banks would be better off by looking at how to get value out of the existing customers, and also attract new customers by offering better quality services, rather than aggressive pricing. “The deposits of banks may rise at a faster pace, if there is a correction in equity markets,” endorsed Ashwini Kumar Tewari, managing director, State Bank of India, who spoke at the sidelines of the same event.

In April, HDFC Bank also announced that it planned to raise Rs60,000 crore in infrastructure bonds and refrain from participating in a price war for deposit mobilisation. Bankers are now realising that they have to somehow beat this trend and are calling for the development of innovative products to reclaim deposit customers. In a recently held FIBAC conference, jointly organised by the Federation of Indian Chambers of Commerce & Industry (FICCI) and the Indian Banks’ Association (IBA), bankers called for the development of innovative products to reclaim deposit customers, who have moved to the equity market. Speaking at one of the sessions, M.V. Rao, MD & CEO, Central Bank of India & chairman, IBA, said: “The returns given by mutual funds are higher. Banks cannot offer more returns to savings account customers, as they are tightly regulated on fund deployment”.

At the same conference, Debadatta Chand, MD & CEO, Bank of Baroda (BoB), observed: “Deposit mobilisation challenge is more of a transient and not a structural issue at this point. At the same time, we as a bank typically need to figure out how to address the change of preference happening for savers.”

Most banks in the recent past have launched special retail deposit schemes for smaller terms of 1-2 years but they have not resorted to offering aggressive rates and have more or less stuck to a bracket of less than 8 per cent. State Bank of India, Bank of Baroda, Bank of India, Bank of Maharashtra, etc, have launched deposit schemes like ‘Amrit Vrishti’ at 7.25 per cent interest on deposits for 444 days, ‘Monsoon Dhamaka’, at 7.25 per cent for 399 days and 7.15 per cent for 333 days, etc, but there are no signs of any rate war.

IMPLICATIONS OF DISPARITY

Liquidity risk: A significant concern arising from the mismatch between deposit growth and credit growth is liquidity risk. If a bank’s credit growth outpaces its deposit growth, it may face challenges in meeting its short-term obligations. This scenario can lead to a liquidity crunch, affecting the bank’s operational efficiency.

Interest rate pressures: To attract deposits, banks may be compelled to increase interest rates on savings accounts. While this may help in the short term, it can increase the overall cost of funds, squeezing the margins of banks and impacting their profitability.

Regulatory scrutiny: The RBI and the finance ministry are likely to closely monitor this trend, as it poses systemic risks to the banking sector. A sustained imbalance could lead to regulatory interventions, impacting the operational autonomy of PSBs.

 Economic growth: The broader implications of this trend extend to the Indian economy. If banks struggle to maintain adequate liquidity and face rising costs, their ability to lend could be curtailed. This, in turn, could stifle economic growth, affecting various sectors that rely on bank financing.

FACTORS CONTRIBUTING TO THE DISPARITY

Changing savings behaviour: With the advent of new investment avenues such as mutual funds, equities, and digital currencies, traditional savings accounts in banks are losing their allure.

Inflation and interest rates: The current inflationary pressures have affected consumer spending power and savings rates. When inflation rises, the real returns on savings accounts diminish, making them less attractive. Additionally, if interest rates on deposits remain low, savers may prefer to invest in assets that promise higher returns.

Increased credit demand: The post-pandemic economic recovery has led to heightened demand for credit, particularly as businesses seek to expand and consumers increase spending. PSBs, in their effort to support economic growth, are focussing on lending, sometimes at the expense of deposit mobilisation.

Regulatory constraints: Stricter regulations and compliance requirements imposed on banks can hamper their ability to attract deposits. The focus on maintaining capital adequacy ratios and managing non-performing assets (NPAs) may lead banks to prioritise lending over deposit mobilisation.

Competition from private banks and fintech: The competitive landscape in the banking sector has intensified, particularly with the rise of private banks and fintech companies offering attractive deposit schemes and innovative financial products. This competition can divert potential depositors away from PSBs.

Looming liquidity challenges?

A survey of banks, jointly conducted by the Federation of Indian Chambers of Commerce and Industry (FICCI) and the Indian Banks’ Association (IBA), has cautioned the banking sector, stating that the system could face liquidity challenges because credit growth is outpacing deposit growth. According to the survey, the priority of top bankers is raising deposits to keep pace with loan growth and keeping the credit cost low.

The survey represents a broad spectrum of the banking sector, considering that it was a large sample survey carried out among 22 banks, including the public sector, private sector and foreign banks, representing about 67 per cent of the banking industry by asset size.

Interestingly, more than two-thirds of respondent banks reported a decrease in the share of current account savings account (CASA) deposits in the survey, which means that the wariness is quite palpable and it could lead to considerable worry in the days to come. However, term deposits have gained momentum as reported by the respondent banks, due to higher/attractive rates.

According to the findings of the survey, more than two-thirds of respondent banks (67 per cent) reported a decrease in the share of CASA (current account, savings account) deposits in total deposits. “As much as 80 per cent of the participating public sector banks reported a decrease in the share of CASA deposits during the first half of 2024, while more than half of the private sector bank respondents reported a decrease in CASA deposits,” the survey states.

The survey also highlighted that customers’ search for higher-yielding investments and the ability to lock in those interest rates for a longer period has led to a shift from low-cost to high-cost deposits, thereby driving up deposit costs for lenders. And, as far as credit demand is concerned, according to the survey, long-term credit demand has seen continued growth for sectors such as infrastructure, metals, iron & steel and engineering, with infrastructure witnessing an increase in credit flow.

More than half (77 per cent) the respondents indicated an increase in long-term loans. The survey also suggests that the outlook for the growth of non-food industry credit over the next six months is optimistic, with 62 per cent of the participating banks expecting non-food industry credit growth to be above 12 per cent.

On the concerns of non-performing assets (NPAs), respondent banks continued to remain sanguine about asset quality prospects in the current round of the survey, cushioned by policy and regulatory support. An overwhelming majority (70 per cent) of public sector respondents expect gross NPAs to be in the range of 2.5-3 per cent, with 44 per cent of private bank respondents expecting NPAs to be in the range of 2-2.5 per cent, while all foreign bank respondents expect NPAs to be in the range of 2.5-3 per cent.