Indian Banks: Will The Life Change After Rs100 Trillion Deposits?

India’s banking sector is celebrating a new milestone—its deposit portfolio crossed Rs100 trillion on 30 September.

It has been a long wait. The collective deposit base of the banking system in Asia’s third largest and the world’s fastest-growing major economy took five years and seven months to double from Rs50.46 trillion in February 2001.

On previous occasions, the deposit base doubled in a much shorter span. For instance, it had taken three years and 11 months to double from Rs25.04 trillion in March 2007; and four years and four months each to double from Rs12.57 trillion in November 2002 and Rs6.26 trillion in June 1998.

Roughly, in the past decade, the deposit portfolio of the Indian banking system has grown five-fold.

Bank credit has also grown five-fold since 2006 and it has been tracking deposit growth. It crossed Rs75 trillion in September 2016 from Rs37.8 trillion in February 2011. In March 2007, the credit portfolio of Indian banks was Rs18.7 trillion.

As a result of this, there has not been a dramatic change in the so-called credit-deposit ratio (credit advanced for every Rs100 collected in deposits).

In March 2001, it was less than 50% and, by 2006, it crossed 70%. Since then, it has risen progressively and crossed 79% in 2013, but in past four years, the credit-deposit ratio has been moving southwards. In March 2016, it was 77.46% and, in September, it dropped further, to 74.14%.

While deposit growth has been tardy (it dropped to a 50-year low in April), credit growth has been even worse. So far, in the current fiscal year, deposits in the banking system have grown 11.3% and credit 10.4%.

Banks are unwilling to lend money for fear of accumulating bad assets. A cheaper loan rate could have enticed more borrowers to knock at banks’ doors for money, but the banks are not able to cut their loan rates as much as they should because of the pile of bad debts they have accumulated. A bank doesn’t earn any interest on bad loans and, on top of that, it needs to set aside money to cover the risk of default. This impairs its ability to cut loan rates.

To put things in perspective, we should look at the growth of deposits and bank credit in relation to the expansion of gross domestic product (GDP)—the deposit-and credit-to-GDP ratios.

The deposit-to-GDP ratio has been growing steadily, from 45.43% in March 2001 to 71.21% in March 2016. For the first time, it crossed 70% in 2010 and after a volatile period of three years, it has been rising—marginally though—since 2013. A similar pattern is seen in the credit-to-GDP ratio although here the growth has been faster. From 24.31% of GDP in March 2001 it has more than doubled to 55.25% in March 2016.

Going by the World Bank and International Monetary Fund data, India’s deposit-to-GDP ratio is higher than that for most countries and the global average. In the absence of any social safety net, a large segment of the population continues to keep money in bank deposits although inflation-adjusted, post-tax return is pretty low.

However, the credit-to-GDP ratio is far lower than the global average. One reason could be the banks’ mandatory buying of government bonds (to the extent of more than one-fifth of their deposits) for meeting the fiscal deficit.

Lower credit-to-GDP ratio is a concern because India’s is primarily a bank-led financial system and the corporate bond market has not taken off.

There have been many theories doing the rounds on why the deposit growth in the banking system has been low. Issuance of tax-free bonds by public sector undertakings, relatively higher interest rates offered by small savings schemes as well as higher spending by savers have been cited as possible reasons. There isn’t much data to conclude that people are investing more in real assets than financial assets.

The value of gold imports, according to Bloomberg, which rose to $57.47 billion in the year to March 2013, dropped to $37.78 billion in the year to March 2016. In the first six months of the current financial year, it is $7.92 billion.

The real estate market has been languishing for the past few years. Meanwhile, assets under management of India’s mutual fund industry has seen steadily rising—from Rs91,000 crore in March 2001 to Rs12.33 trillion in March 2016 and Rs15.8 trillion in September.

There is no need to worry too much about the low deposit growth. The situation is likely to change with new banks coming up.

The sector witnessed the entry of two new universal banks a little more than a year ago and two small finance banks have recently started operations. Eight more small finance banks and an equal number of payments banks are expected to start operations over the next few months. Most of these banks are likely to reach out to new customers who have not been served by the high street bankers. Attracted by high interest rates, many in rural India have lost money to chit funds. Wiser with experience, they will probably park their money with the new banks. Besides, the new entities will also create savings habits among those who are used to only borrowing money.

The need of the hour is better transmission of monetary policy. The banks have not been able to cut their loan rates by as much as the Reserve Bank of India has cut its policy rate or even the drop in the deposits rates.

The heap of bad loans is to be blamed for this. Hopefully, the new banks will trigger competition, at least in some pockets of the economy, and force others to cut loan rates. Once the banks start lending more money, deposits too will grow faster, driven by the so-called money multiplier effect.

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank.

His Twitter handle is @tamalbandyo.

Comments are welcome at [email protected].

This blog first appeared in www.livemint.com