Shaktikanta Das and the brewing challenge of slowing bank deposits

Specifically, the problem is bank deposits growing slower than credit growth—13.5% against 16% (without taking into account the HDFC Ltd merger with HDFC Bank, which took effect only in June 2023)—and this is introducing a skew in key banking metrics, apart from adding a fresh risk element to the financial stability matrix.

Read this: Indian banks are battling the worst deposit crunch in 20 years

The continuing concern has even prompted a personal intervention from RBI governor Shaktikanta Das. He met with the chief executives and managing directors of all the public sector banks, as well as select private sector banks, on 3 July in the presence of RBI deputy governors and executive directors. Interestingly, topping the meeting agenda was the item: “Persisting gap between credit and deposit growth".

There are legitimate reasons for the growing anxiety over slow deposit growth. A critical reason is its role as a key ingredient for economic growth.

The government has been frontloading capital expenditure and infrastructure spending in the hope of catalyzing private sector investment and kick-starting broad-based economic growth. Whenever private investment does start picking up, banks and other lending agencies have to be ready to meet the demand for fresh credit. In such an event, slow deposit growth might force banks to either resort to market borrowings to feed private industry’s growing loan appetite or, if costs and margins go out of whack, to slow down credit disbursal. Both alternative scenarios have the potential to dampen the growth impetus.

The deposit conundrum has not developed overnight; it has been a work-in-progress for some time now. There are four reasons why RBI and banks are suddenly confronted with this problem.

More here | Mint Explainer: Behind the worst bank deposit crunch in nearly 20 years

The first is the relative unattractiveness of bank deposits compared with other forms of investment available to investors. Take the 6.8% one-year fixed deposit rate offered by the public sector State Bank of India (SBI), India’s largest commercial bank. At 4.75% consumer inflation for May 2024 and the prevailing tax rates, the post-inflation and post-tax yield works out to around 1.4%, which pales when compared with most other competing asset classes in the economy. For example, the stock market has been on fire for the past three to four years. Even for risk-averse individuals, astute investments in mutual funds (leavened with perhaps moderate risks) have the potential of earning over 10-12% returns.

Even the tax-free fixed deposit scheme offered by the government does not seem to have gained much traction for two reasons: to be eligible for the tax break, one, interest income has to be within the overall ₹1.5-lakh exemption under Section 80C of the Income Tax Act and, two, funds in the fixed deposit have to stay locked in for five years. There is now a demand to further liberalize this category of deposits.

The other reason for slow deposit growth has been the banking sector’s near-stagnant physical presence. Banks, influenced by societal hype about the primacy of digital outreach, halted the expansion of brick-and-mortar branches. Many bank chief executives, who had their bonuses linked to margin growth and market cap increases, also went slow on branch expansion to lower costs and boost bottomlines. There is now a belated realization that physical branches play a critical role in customer acquisition and deposit growth. Many leading banks are now making amends by setting aside capital expenditure to aggressively expand their physical footprint, to go hand-in-hand with increased investments in direct marketing and digital outreach.

There is another reason for the overdue push for branches. Within the banking system, the nature of the deposit mix is changing and moving towards high-cost deposits. Banks have traditionally relied on cheaper current-account-savings-account (CASA) deposits as a source of perennial low-cost funds. However, RBI data shows that CASA’s share has been shrinking in the overall mix, which has been compensated by some growth in costlier term deposits. The resulting pressure on margins may have also impelled bank management to revive CASA’s share by focusing on branch networks.

But, beyond the structural issues within the banking system, trends in the broader economy have also led to slow deposit growth.

Sluggish growth in private consumption expenditure during 2023-24 indicates income and employment stress in the economy and has set in motion a chain reaction. Income and employment stress shrink individual disposable incomes and, predictably, have a direct impact on retail deposits. But this also affects corporate deposits in the banking system. Slower consumption growth has resulted in slower growth in corporate top lines, which leaves them with lower surpluses to park in bank deposits. Slower top-line growth also impacts the corporate working capital cycle, which then automatically lengthens the payment cycle for all vendors in the supply chain. This, then, also has a bearing on their ability to maintain deposits with the banking system.

Also read: How Shaktikanta Das is fixing the problem of wayward bank interest rates

There was a time when interest from fixed deposits was a staple and reliable income source for many Indian households, especially for retired individuals. The drive to keep interest rates low, without providing for alternative income sources that not only provide for basic needs but also help meet medical costs, has had the unintended consequence of rendering the new pension scheme unpopular.

These challenges must be addressed to ensure economic stability and growth.