BANK DEPOSITS: Barking Up The Wrong Tree?

What do Finance Minister Nirmala Sitharaman, Reserve Bank of India (RBI) Governor Shaktikanta Das, and Financial Services Secretary Vivek Joshi have in common? All three are concerned about the slow deposit growth in the banking sector. The industry is facing one of its toughest challenges in raising deposits to keep up with credit growth.

As of July 26, the deposit portfolio of all scheduled commercial banks stood at Rs 211.93 trillion, while credit reached Rs 168.14 trillion. So far this financial year, deposit growth has been 3.5 per cent, compared to a 2.3 per cent increase in credit. However, over the past year, deposit growth has been 10.6 per cent, significantly lower than the 13.7 per cent growth in credit.

Around the same time in 2023, the year-on-year deposit growth was 12.9 per cent against a 19.7 per cent increase in credit. In 2022, the figures were 9.2 per cent and 14.5 per cent, respectively.

When deposit growth lags behind credit growth, banks end up with a higher credit to deposit (CD) ratio. For every Rs 100 in deposits, banks must keep Rs 4.5 with the RBI as a cash reserve ratio, and another Rs 18 is invested in government bonds.

Theoretically, this leaves banks with Rs 78.5 for every Rs 100 deposit to lend. In reality, the amount is often lower due to higher investment in bonds. Of course, banks can use capital to lend.

In mid-July, the average CD ratio of the banking system was 79.39 per cent, down from 80.25 per cent in mid-March. However, some banks — both universal and small finance banks — continue to report a CD ratio above 100 per cent.

When deposit growth is slow, banks must raise money from the market in the form of commercial papers (CPs) and certificates of deposit.?In FY24, banks raised Rs 9.56 trillion through certificates of deposit, 31 per cent higher than the Rs 7.28 trillion raised the previous year. Such funds are costlier, and CPs, in particular, have a short tenure.

Low-cost current and savings accounts (CASA) made up 43 per cent of total deposits last year, down from 45 per cent the previous year. Currently, they account for 41 per cent. While this is not a significant problem — CASA was even lower in the mid-2010s — intensifying competition means banks must find new ways to attract deposits.

The conventional way to attract deposits is by offering higher interest rates. Some small finance banks are offering between 8 and 9 per cent for fixed deposits of one to two years, while others offer between 6.5 and 8 per cent for the same maturity. Senior citizens typically earn an additional half per cent, and some banks offer even more to super senior citizens (80 and above). There is no gender bias when it comes to interest rates on bank deposits.

In Zimbabwe, banks are offering 110 per cent interest on deposits — the highest in the world. Argentina follows with 69.89 per cent. Other countries in the top ten include Turkey (43.5 per cent), Venezuela (36 per cent), Uzbekistan (18.4 per cent), Sierra Leone (15.75 per cent), Egypt (14.49 per cent), Colombia (13.21 per cent), Madagascar (13 per cent), and Mongolia (11.6 per cent).

The reason for offering such high interest rates is high inflation. India is a different story. Here, banks must find ways to attract more deposits to keep up with credit growth. If they fail, credit growth will slow, impacting economic growth. Additionally, the banks also run the risk of asset-liability mismatches (lack of enough liabilities or deposits to match the assets or credit) – both in quantum and maturity.

Barring the creation of different buckets, and branding them under different names, little innovation has been seen in deposit offerings.

Floating rate deposits — where the rate is linked to an external benchmark — have not gained popularity. Savers often opt for recurring deposits, contributing money monthly for specific purposes. Many banks now offer a sweeping facility, where funds in a savings account automatically move to a fixed deposit once they exceed a certain threshold, earning a higher interest rate.

The interest rate on savings accounts was deregulated in 2011, but most public sector banks still offer low rates. Some private banks offer higher rates, often in a staggered manner, with higher rates kicking in as account balances grow. A few banks now offer monthly interest payments on savings accounts.

There is no interest on current accounts, but account holders receive benefits such as overdraft facilities (allowing withdrawals even when the account balance is zero). Every bank aims for a high CASA ratio,?because higher the CASA, the lower the overall cost of deposits.

The weighted average rate of outstanding rupee term deposits at scheduled commercial banks was 5.13 per cent in June 2022. It rose to 6.47 per cent in June 2023, and 6.91 per cent in June 2024. Aside from offering higher interest rates, what else can banks do to attract depositors?

Finance Minister Sitharaman has asked the banks to look for small deposits. Incidentally, nearly a century ago, in 1928, Syndicate Bank (which merged with Canara Bank in April 2020) introduced the pigmy deposit scheme.?Its agents travelled to the doorsteps of farmers and shopkeepers to collect deposits. A depositor had the flexibility to save as little as 25 paise daily, weekly, or monthly. By saving daily, at the end of seven years, this would have accumulated to Rs 700 at a simple interest rate of 3.5 per cent.

Syndicate Bank encouraged its employees to work as pigmy deposit agents during their spare time. By 1960, 21 per cent of the bank’s net deposits came from pigmy deposits. However, in 1962, the RBI barred the bank from using its employees as agents. Banks cannot follow this model today due?as the cost of collection is very?high.

The popular perception today is that savers are exploring other avenues to park their money – in equities (directly or through mutual funds), real estate and gold. The rise in demat accounts and the phenomenal growth in mutual fund assets under management bear testimony to that.

Ultimately, though, the money remains within the system in different pockets. This means, beyond deposits, banks need to raise funds from the market,?a la?developed economies. Every effort needs to be made for the growth of the corporate bond market.

Finally, not everyone has money to save. India’s household net financial savings plunged to a five-year low of Rs 14.2 trillion in FY23, sharply down from Rs 17.1 trillion in FY22. As a percentage of GDP, household net financial savings in FY23 dropped to 5.3 per cent, the lowest in around five decades. Between FY12 and FY22 (excluding the Covid-19 year, FY21), net financial savings averaged 7-8 per cent of GDP.

A recent report by Swiss bank UBS points out that Indian households are saving less due to weaker income, a greater tendency to consume, and rising debt obligations. The bottom 20 per cent of households in both urban and rural India spend almost 80 per cent of their consumption on food, fuel, electricity, and clothing.

Avoiding any reference to a particular letter in the English alphabet to describe India’s current growth story, it’s clear that inclusive growth is the solution to the problem.

Let me conclude this column with a story from a poem by Rabindranath Tagore. A barefoot king once sought to keep his feet clean from the dust of the road. The challenge was how to ensure this? First, sweepers tried to clean the roads, but the resulting dust storm made the king ill. Then, butchers began killing goats and cows to collect enough leather to cover the roads, but that also failed. Finally, a cobbler entered the king’s court, measured the king’s feet, and stitched a pair of sandals. That solved the problem.

We know what needs to be done. Shouldn’t we stop barking up the wrong tree?

This column first appeared in Business Standard. The writer, a Consulting Editor with Business Standard, is Senior Adviser to Jana Small Finance Bank. Writes Banker's Trust every Monday.

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