Opinion
A classic scramble for deposits has erupted among banks again
Summary
- Low interest rates, bank inertia and structural changes have made deposits hard to find in the face of rising credit demand.
Things declared obsolete prematurely have a way of pushing back. A critical component of ‘boring’ banking—ordinary deposits—is having a moment because Indian banks are faced with a depleting deposit stream, thus pushing up costs and squeezing margins. The traditional market for deposits is also undergoing some serious structural changes, which is likely to impact bank performance over the next few quarters.
Two developments have led to a deceleration in deposit growth. First, years of regulatory obsession with keeping nominal interest rates low (even after real rates occasionally turned negative) diverted part of the country’s incremental household savings to alternative assets, such as mutual funds. This was manifest when the mutual fund industry’s assets under management crossed ₹50 trillion in December 2023. To put the number in context, the comparable figure in December 2013 was only ₹884,631 crore. Category-wise data from the Association of Mutual Funds in India points to another interesting trend: at end-September 2023, household investment (retail plus high net worth individuals) in equity mutual funds was three times the sum of wholesale investments (corporates and banks plus foreign portfolio investors).
The other reason has been the banking system’s lethargy in raising deposit rates, even after the Reserve Bank of India (RBI) increased benchmark rates. Banks are traditionally prompt in raising lending rates when RBI hikes rates but are sluggish in increasing deposit rates. The opposite holds true when RBI cuts rates: deposit rates drop faster than lending rates. In short, it’s a lose-lose proposition for depositors. On the greener side of the fence, equity markets have been on fire over the past 12-18 months and this further induced depositors to divert their investible surpluses. A third probable reason could be the 2016 demonetization episode, which discouraged people from putting their money in banks (see 2017 data in chart).
A combination of these factors has led to some skews over the past two years. Aggregate deposit growth during calendar 2023 stood at 12.5%, an improvement over the previous year. But, somewhat counter-intuitively, bank credit grew faster, by 15.64%, during the same period. Consequently, many banks (particularly private ones) reported a credit-deposit ratio of over 100%, which implies that they had to seek non-deposit liabilities to fund growing demand for loans. But this came about when RBI was draining out excess liquidity from the system, over and above its rate hikes, which pushed inter-bank and debt-market rates higher and increased borrowing costs for banks issuing certificates of deposit.
Bankers are now waking up, somewhat belatedly, to the significance of deposit mobilization for their basic banking business. In the easy-money era, when fee income fattened bottom-lines and cheap money could be accessed from a number of alternative sources, bankers found the notion of deposits rather old-fashioned, a vestige of the command-and-control days. Once RBI’s anti-inflationary moves slowed down the carousel and trimmed fee incomes, bankers looking to the credit business for sustenance have hit a wall due to low deposit growth. This has underlined the fundamental importance of deposits.
Basic banking, drilled down to its core, requires only two critical inputs or raw materials: capital and human beings. Labour availability was never a problem in India, though it can be argued whether the available quality ever matches demand. On the capital side, banks usually aggregate money through equity, deposits from the public and market borrowings. In India, banks have aggressively focused on deposit mobilization since bank nationalization in 1969, done as part of a larger socialist economic model.
Banks were then found to be handy instruments for furthering the government’s developmental goals. RBI data shows that there was a massive expansion in branch network, with a special emphasis laid on rural areas. Consequently, the banking industry’s deposit collection rose seven times in just 10 years: from ₹4,646 crore in 1969-70 to ₹33,377 crore by 1970-80. Deposit generation became critical for financing the government’s social sector expenditure, with funds pre-empted through high regulatory reserves. Even after the onset of the 1991 economic reforms, an under-developed debt market forced banks to keep relying on deposits.
And now, once again, plain-vanilla deposits are back in fashion. Ironically, so are brick-and-mortar bank branches, once derided as costly appendages. This has precipitated a structural reshuffle in the deposit market that is bound to have some consequences for bank bottom-lines. As industry chips fall wherever they will, it is likely that banks with extensive branch networks will corner a larger share of the market for deposits. Some leading banks, in both the public and private sectors, have been investing in expanding their branch network steadily, making inroads into one district after another. They are combining this expanding physical presence with direct marketing through teams of sales officers and digital outreach efforts. Banks that are unable to invest as extensively in branch coverage will be forced to rely on a more costly mix of deposits and market borrowings. This is bound to shake up parts of the industry. Till, of course, the next episode of easy money.
