New Delhi [India], August 26 (ANI): The decline in loan-to-deposit ratios (LDR) within the banking system has been attributed to lower money creation by the Reserve Bank of India (RBI) and higher profits accrued by banks over the past two years, according to Nomura report.
One of the contributors to the decline in systemic LDR is the lower net money creation by the RBI over the fiscal year 2023-24. Cumulative net fresh money creation during this period amounted to only Rs 0.6 trillion, a contrast to approximately Rs 20 trillion created in the three fiscal years preceding it (FY20-22). This represents a drop in money supply compared to previous years.
In the fiscal year 2023-24, the net money creation by the RBI was virtually neutral, recording -1 per cent in FY23 and +1 per cent in FY24, against a 20-year average of +3 per cent and a higher +4-5 per cent in the earlier three years.
This moderation in money supply, a discretionary move by the RBI, has had a notable impact on the LDR, limiting the ability of banks to expand their lending relative to deposits.
Another crucial factor influencing the decline in LDR is the substantial increase in bank profits over the last two years. In FY24, the total profit of banks was 1.8 per cent of the previous year’s deposits, a rise from the average of 0.1 per cent observed between FY16-20. This increase in profitability, while indicative of strong financial performance, has led to a reduction in deposits as banks appropriate a larger portion of these profits.
The relationship between bank profits and deposits is intrinsic; banks generate profits from their operations, which are ultimately derived from depositors’ funds.
As banks’ profits rise, the balance sheet needs to be adjusted accordingly, often leading to a reduction in deposits. Consequently, higher profits can result in a diminished deposit base, further impacting the LDR.
The elevated LDR, driven by these factors, should be viewed as a cyclical phenomenon rather than a systemic issue. The argument that banks are failing to mobilize deposits or that money is being diverted elsewhere is misplaced.
Instead, flows into capital markets and the muted growth in currency in circulation over the past two years do not directly impact system deposits.
Banks have continued to create deposits through credit expansion, and the factors leading to the higher LDR are beyond their control. The lower money creation by the RBI is a cyclical issue that is expected to correct over time, while the higher bank profits reflect a positive trend rather than a problem. (ANI)
