The Tug of War between Deposits and Loans

India's banking sector is grappling with a growing gap between deposit and credit growth. As of June 2024, deposits grew by 11.7%, while credit surged by 15%, pushing the credit-deposit (CD) ratio to a 19-year high. The widening gap between deposit and credit growth has raised concerns about a potential asset-liability mismatch for banks. In response, the RBI and the government have encouraged banks to focus on increasing deposit growth through innovative strategies. However, this approach has been met with some criticism from commentators.

While some analysts argue that the deposit issue is overstated and that banks do not face significant constraints in lending, a closer analysis suggests that addressing the deposit shortfall remains important for the stability of the banking sector.

During the pandemic, government borrowings surged while credit growth slowed, leading many banks to accumulate a significant stock of statutory liquidity ratio (SLR) securities. As the economy recovered, instead of raising deposit interest rates—which would have impacted their net interest margins—many banks chose to liquidate their excess SLR securities to meet the rising credit demand.

Another factor contributing to sluggish deposit growth is the large cash balances held by both the central and state governments with the RBI during the election season, which created short-term liquidity issues. However, liquidity improved once the government resumed spending. In August, media reports indicated that banks had urged the finance ministry to allow them, rather than the RBI, to hold these government cash balances to improve liquidity. Under the new Cash Management Framework, SNA-SPARSH, introduced in 2021, government cash balances were redirected to the RBI instead of commercial banks.

While loans typically lead to deposit creation, past data shows that deposit mobilization tends to be faster when incremental bank lending is driven by corporate (wholesale) lending rather than retail lending (excluding home loans). In the current phase, with retail lending growing rapidly—particularly through credit cards, unsecured personal loans, and similar products—the pace of deposit mobilization has been slower.

To address asset-liability management (ALM) concerns, many banks are now turning to the infrastructure bond market. This approach is advantageous as such bonds are exempt from regulatory reserve requirements like the SLR and cash reserve ratio (CRR). Additionally, these instruments offer attractive spreads and have strong demand among long-term investors. The focus is now shifting from the credit-deposit ratio to the Credit to 'Deposits + Borrowings' ratio.