Several large banks have increased their medium-term deposit rates by 15-20 basis points over the last few weeks at a time when system liquidity remains sufficient, and the government expected to release funds after a temporary hold-up due to general elections.
The hike in deposit rates appears counter-intuitive, especially as market stakeholders anticipate a cut in interest rates by the Reserve Bank of India (RBI) by the third quarter of the current fiscal year based on a high likelihood of the Federal Reserve slashing rates by 50-75 basis points by December 2024.
Lagging deposit growth Behind credit growth
One of the primary reasons for the increase in deposit rates is the persistent lag in deposit growth compared to credit growth. Over the past three years, bank credit advances grew by 15.6%, while aggregate deposits grew by only 10.9%, reflecting a substantial gap of 470 basis points. Although the credit-deposit growth gap has reduced to 270 basis points in the last year, it remains significant. As of July 2024, the credit-deposit ratio of the Indian banking system stood at a high of 79.4%, with the incremental credit-deposit ratio at 95.8%. These metrics have raised concerns for the central bank.
Structural issues
There are several structural issues contribute to the challenges in deposit mobilisation including partial transmission of rate hikes. Between May 2022 and February 2023, the RBI raised the repo rate by 250 basis points. However, this hike was not fully transmitted to deposit holders, with the highest deposit rates for the largest banks currently around 7.25%, translating to a post-tax yield of only 5.1%. Low yields have impacted the share of banking deposits in household savings.
Households have consistently derived higher returns from equity markets and equity mutual funds over the last three years, with returns ranging between 15%-30%. This has led to a diversion of household savings away from bank deposits.
Small finance banks offer term deposit rates that are 100-200 basis points higher than those of larger banks, attracting more depositors.
The ease of financial transactions and fund transfers due to internet banking and mobile applications has facilitated a swift shift of funds from bank accounts to equity markets and mutual funds. This technological shift has also reduced the stability of CASA (current account-savings account) deposits.
The RBI has revised the LCR for banks, requiring an additional run-off factor of 5% on retail deposits with internet and mobile banking facilities. This has impacted the LCR of banks and increased the competition for longer-term and more stable deposits.
