In what could be music to Indian banks’ ears, deposit growth outpaced credit offtake for the fortnight ending July 12, 2024. The slower credit growth was due to the high base effect and banks’ efforts to manage the credit-to-deposit (CD) ratio.
Yet, don’t get too excited just yet—this uptick might be just a blip in an ongoing challenge for Indian banks. HDFC Bank Managing Director Sashidhar Jagdishan recently voiced his frustration over lackluster deposit figures for the quarter ending June, noting that unexpected volatility in current account flows caught the banking giant off guard.
“I know that the most important part of our strategy is deposits, and are we happy with the kind of numbers that have come about? Not really,” Jagdishan had said.
Indian banks are facing a daunting dilemma as urban savers increasingly flock to higher-yielding investments like mutual funds and stocks, undermining banks’ traditional advantage of low-cost deposits. The rush for equities is such that the head of the country’s largest lender, State Bank of India, feels even tax tweaks on capital gains are unlikely to significantly boost deposit growth.
Reserve Bank of India Governor Shaktikanta Das while announcing the monetary policy once again flagged the issue of rising retail money finding its way into alternative investment routes and said it could pose structural issues for India’s banks
This shift in consumer preference is contributing to what could be the most severe deposit drought in nearly two decades.
Das had also said the RBI is worried about the structural changes in the financial sector, as credit growth is outpacing deposit growth, which could lead to liquidity challenges for the banking system.
Also Read: RBI Governor Das again flags a big worry for banks
Why are deposits important for banks and what’s the threat?
Deposit growth is crucial for banks as it provides a stable and low-cost source of funds, essential for financing loans and maintaining liquidity. High deposit levels enable banks to offer competitive interest rates on loans, support their operational needs, and meet regulatory requirements. When deposit growth falters, banks face significant risks, including reduced capacity to lend, increased reliance on more expensive funding sources, and potential liquidity issues. This can lead to higher borrowing costs, diminished profitability, and a strained ability to manage credit risks effectively. In the long run, insufficient deposit growth can undermine a bank’s financial stability and growth prospects.The lending which banks have to do now due to the shortage of deposits will lead to lower NIMs as the cost of funds increases, said Shravan Shetty, Managing Director at Primus Partners.
“We believe this will lead banks to look at non-core revenue like commission from selling other financial products to increase revenue and profit margins,” he added.
Also Read: Banks’ profits healthy, but margins may shrink and deposits could disappoint
What are banks doing to address deposit growth challenges?
In response, banks are exploring rare and drastic measures to address the issue. For instance, under regulatory pressure to improve credit-deposit ratios, private banks are beginning to sell off portfolios of retail loans—a significant departure from their usual practices.
ICICI Bank, India’s second-largest lender, is preparing to expand its deposit base by targeting self-employed individuals, increasing its private banking and wealth management clients, and focusing on family offices.
Bank deposit challenges: Who should take the blame?
However, consumers can’t be blamed for this as they will only park money where they think will get them the most ‘cash back’. Perhaps, the blame is also on the dismal savings rates and ineffective policy transmission by banks.
For commercial banks, the CASA (Current Account Savings Account) ratio has dropped from 45% in FY22 to 41% in FY24. Bankers and analysts point to the growing disparity between interest rates on term deposits and savings accounts as a key factor. While savings account rates hover around 3-3.5%, term deposits can offer interest rates as high as 7% to 7.75%.
Also Read: Banks borrow more than they raise deposits to fund loan demand
The CASA ratio is vital for banks because it measures the share of low-cost, stable deposits, which lowers their overall cost of funds. A higher CASA ratio boosts profitability by widening the gap between interest earned on loans and interest paid on deposits.
So, did the banks got themselves into this trouble where they are now taking uncommon measures? For example, under regulatory pressure to enhance credit-deposit ratios, India’s private banks are now selling portfolios of retail loans. This move marks a rare shift in the Indian banking sector, where such sales have been uncommon.
To answer why consumers are likely ditching deposits, Vijay Mani, Partner, Banking and Capital Markets Leader, Deloitte, said, “A potential cause (not something we’ve confirmed empirically) is the need for a greater hedge against inflation.”
As inflation stays high, and if the capital markets growth continues to beat inflation by a big margin, Mani says, there will be a flight to growth.
“Having said that, if there are corrections in the capital markets, one may also see a flight to safety of bank deposits, especially time deposits,” he added.
Also Read: HDFC Bank to grow deposits aggressively, slowdown loan growth
Flocking to other investments: Why are bank deposits falling?
The shift in investment preferences is driving this trend. Bankers point out that, with the attractive returns offered by equities, mutual funds, and tax-saving equity-linked savings schemes (ELSS), investors are increasingly turning away from traditional tax-saving fixed deposits (FDs).
Shaktikanta Das earlier in July had said that households are increasingly choosing capital markets over traditional banks for their savings.
Das said that banks have historically been the primary option for households to deposit their savings. However, there has been a noticeable trend showing a growing preference for capital markets and other financial intermediaries.
As per the economic survey 2023-24, individual (retail) investors have around Rs 36 lakh crore in direct equities and Rs 28 lakh crore in assets under management of mutual funds. Individual investors are over 9.5 crore and have nearly 10% direct ownership of the market through its almost 2,500 listed companies.
Over FY 22-24, aggregate bank deposits grew at a 11.5 per cent CAGR, while mutual funds AUM grew at a much higher rate, i.e. 19.2 per cent CAGR, according to Deloitte.
In FY24, this difference was far more marked, i.e. 35.5 per cent YoY growth in MF AUM vs 13.5 per cent YoY growth in aggregate bank deposits.
Indians are betting on mutual funds like never before
Indian consumers are expanding their investment horizon to include mutual funds and other financial intermediaries.
The shift is on account of investors diverting the funds towards other investment avenues such as equity mutual funds on expectation of better return on investment, increased awareness, and ease of investing via multiple avenues, said Aniket Dani, Director- Research at CRISIL Market Intelligence and Analytics.
The share of equity mutual funds has increased from 48 per cent (Rs. 14.79 trillion) as of March 31, 2021, to 65 per cent (Rs. 34.28 trillion) as of March 31, 2024.
The shift in investment patterns carries significant implications for India’s banking sector. Nonetheless, the shift is coming despite major losses for many.
A Sebi study had earlier pointed to 90 per cent of the trades resulting in losses.
Moreover, Sebi chairperson Madhabi Puri said households are losing up to Rs 60,000 crore a year in the problematic futures and options segment.
Banks need a new game plan?
Banks’ deposit growth in FY24 was well below the rise in credit, forcing them to meet the funding gap through higher-cost Certificates of Deposit (CDs).
In FY24, aggregate deposits grew 12.9% compared with a 16.3% rise in bank credit, as investors preferred alternative avenues to park their money.
“As capital markets grow in India, if FY24 keeps repeating itself, i.e. growth in deposits keeps falling below growth in MF AUMs/ other capital markets avenues, this could certainly have an impact on banking growth and is a scenario for which bankers would need to have a strategy,” Deloitte’s Mani said.
Banks need to devise new strategies to attract depositors, financial services secretary Vivek Joshi said, even as he noted that Indian banks’ low-cost deposits, current and savings accounts (CASA), are comfortable at around 41% of their total deposits.
Echoing a similar opinion, Governor Das also indicated that banks must explore new methods to manage the gap between credit and deposits.
“On their part, banks have sought to fill the credit-deposit gap by increasing their reliance on other sources like short-term borrowings and certificates of deposit, etc. This increases their sensitivity to interest rate movements and poses challenges to liquidity management,” RBI governor said.
The governor highlighted the transition from CASA (Current Account Saving Account) deposits and the need for banks to be adaptive and vigilant. He urged banks to consistently focus on refining their credit underwriting standards and risk pricing to maintain stability and profitability.
Meanwhile, “In the short-term banks will have to increase interest rates to attract deposits or resort to higher cost certificates of deposits which is expected to impact the margins and in turn profitability,” suggested CRISIL’s Aniket.
