The curious case of deposits

There has been quite a brouhaha over the rising CDR (Credit to Deposit ratio) in Indian banking recently.

CDR is an important indicator of a bank's liquidity and credit risk, however, there is no hard and fast rule around it by the RBI. The RBI considers a CDR range of 70-80% as a comfortable level for Indian banks and the average CDR for Indian banks has indeed been hovering around 80%. So why this hue and cry?

A higher CDR means a higher growth of credit(or lending) without a proportionate increase in deposits. The question arises where is the bank deposit going??

The deposit growth in banks YOY has been steady but not enough to keep pace with the demand for borrowing. Commercial banks worldwide are facing erosion in their deposits.?

As per McKinsey, the global financial system currently holds $402 trillion in assets, with over half of this amount residing outside of bank balance sheets. In the last 10 years, 75% of the net increases have been allocated to mutual funds, insurance balance sheets, pension funds, sovereign wealth funds, and private capital.?

While retail deposits are the cheapest source of funds for banks to lend, globally, retail investors have been favouring equity and capital markets over safe havens of bank deposits, due to an increase in awareness and ease of investing. This is playing out in India too, with some additional irony. For over two decades, in a pressure to generate fee based income, bank employees were pushed hard to sell investment products (bancassurance and Mutual funds). They were encouraged in their discussions with customers to sneer at the humble deposit, so as to create demand for these alternative investments. The tactic worked only too well and has now boomeranged on banks. We prefer mutual funds, equity investments, gold or even real estate - deposits are only for unimaginative chumpts. This has been further aided by the consumerisation of personal finance - it is now as easy to buy stocks or mutual funds as it is to order a pizza. Another important factor contributing to this, I see, is that the banks have been protective about embedding their deposits in the distribution channels of third parties. You rarely find a stock broking firm selling you a FD of a HDFC Bank.

How could the banks re-energize their share of retail savings? No quick wins that I can see but thankfully the banks do have access to the regulator’s and the government’s ears. If they can use that access, some possibilities emerge:

1. SEBI recently directed Mutual funds to frame policies to protect the interest of investors in small and mid-cap schemes to curb ‘market froth’. This has already caused a sharp decline in the share prices of mid-caps and especially small-caps. The chances are that some of the capital that would have been lured by the promise of quick and high returns in these segments will now be parked with banks

2. The banks could do their bit to promote a bit more awareness on the downsides to MFs such as exit costs and the 1-3 working days needed to receive funds after selling mutual funds. The bank’s argument could be that unlike MFs, FDs can be redeemed instantaneously (for digitalised banks) in an emergency, so purely from a liquidity perspective, FDs are better than MFs.

3. Bankers could lobby for more tax relief on interests earned on FDs on the basis that savings parked with banks are the springwell of credit in the economy. If these dry up, the economy could be left with an ugly credit crunch

4. Look to innovate to make savings more interesting. One example could be mortgage offsets - i.e. a construct where e.g. on a Rs. 1 cr home loan principal, if the consumer saves say? Rs. 5 lakhs with the bank, interest is automatically levied only on the balance Rs. 95 Lakhs for as long as the FD is maintained.

5. Another easy peasy solution is to raise the FD rates a bit to make them lucrative again.

It will be interesting to see how things shape up from here. It is true that without a cheap source of funds i.e. retail deposits… credit cost and availability will be impacted with severe downstream consequences! Let’s hope that our bankers and our regulators figure out a path ahead that is effective without being overly harsh on retail investors.