Indian Banks at a Crossroads: Navigating Deposit Growth and Credit Demand
October 19, 2024, 5:33 am
The Indian banking sector is experiencing a pivotal moment. Recent data reveals a significant shift in deposit growth, as banks scramble to attract funds amidst rising interest rates. This trend is not just a blip; it signals deeper structural changes in the funding landscape of Indian banks.
In the fortnight ending October 4, 2024, banks reported a remarkable surge in deposits, outpacing credit offtake by a wide margin. This is a refreshing change after several quarters of sluggish deposit growth. The figures tell a compelling story: banks accumulated ₹4,20,217 crore in deposits, while credit offtake stood at ₹1,75,363 crore. This shift could help alleviate the high credit-deposit ratio that has plagued the banking system.
Why the sudden uptick? Banks have been proactive. They’ve rolled out attractive interest rates on term deposits, particularly for 1-2 year tenors. The Reserve Bank of India (RBI) has played a crucial role, raising the policy repo rate by 250 basis points since May 2022. This has nudged the weighted average domestic term deposit rate (WADTDR) upward, making deposits more appealing to savers.
However, the landscape is not without its challenges. Fitch Ratings has raised concerns about the long-term funding mix of Indian banks. The agency predicts a gradual increase in the share of borrowings within the overall funding mix. Currently, borrowings account for about 10% of the mix. If banks cannot attract sufficient low-cost long-term resources, funding costs will inevitably rise.
The shift from low-cost deposits to term deposits is a common reaction to high interest rates. Yet, the share of low-cost deposits has plummeted to a two-decade low of 20% in FY24. This trend poses a risk. If deposit growth continues to lag behind loan growth, the loan-to-deposit ratio (LDR) could remain elevated, leading to structural issues within the banking system.
The data paints a stark picture. Between FY14 and FY24, deposit growth matched loan growth at a compounded annual growth rate (CAGR) of 9.4%. However, since FY21, the LDR has surged by 10 percentage points. This imbalance raises alarms about the sustainability of current deposit pricing strategies. If banks are to support the economy's reliance on credit, they must focus on growing deposits.
Fitch’s analysis indicates that the current deposit pricing strategy may not hold up in the long run. The agency does not foresee immediate pressure on banks' viability ratings, but warns that individual key rating factors may need reassessment if margins, growth, and liquidity management are adversely affected.
Moreover, the rise of mutual funds (MFs) presents another challenge. Since FY17, MF investments have grown at a staggering 24% CAGR. As capital markets perform well, retail savings are increasingly shifting away from traditional bank deposits. Demographic changes and the rise of digital banking are accelerating this trend.
Fitch suggests that a broader depositor base beyond the top 15 urban centers could bolster inflows and enhance deposit retention. Currently, these urban centers account for 65% of MF assets and 44% of bank deposits. Expanding the depositor base could be a lifeline for banks struggling to maintain their deposit growth.
The pressure on margins is palpable. A continued rise in the LDR could exacerbate margin pressures beyond expectations. Indian banks have limited pricing power, which hampers their ability to fully pass on increased funding costs. This situation may compel banks to take on additional risks to maintain profitability.
Liquidity management is another critical area of concern. The RBI's liquidity stance and government-linked inflows could alleviate some pressure, as seen in the past. However, declining flows due to lower real returns on deposits could heighten the strain on LDR and asset-liability management.
In summary, Indian banks are at a crossroads. The recent surge in deposits is a welcome development, but it masks underlying challenges. The shift in depositor behavior, rising funding costs, and the growing prominence of mutual funds complicate the landscape. Banks must adapt swiftly to these changes. They need to innovate their deposit strategies and enhance their appeal to a broader range of depositors.
The road ahead is fraught with challenges, but it also presents opportunities. By embracing change and focusing on sustainable growth, Indian banks can navigate this complex terrain. The future of banking in India hinges on their ability to balance deposit growth with credit demand, ensuring stability in an ever-evolving financial ecosystem.
In the fortnight ending October 4, 2024, banks reported a remarkable surge in deposits, outpacing credit offtake by a wide margin. This is a refreshing change after several quarters of sluggish deposit growth. The figures tell a compelling story: banks accumulated ₹4,20,217 crore in deposits, while credit offtake stood at ₹1,75,363 crore. This shift could help alleviate the high credit-deposit ratio that has plagued the banking system.
Why the sudden uptick? Banks have been proactive. They’ve rolled out attractive interest rates on term deposits, particularly for 1-2 year tenors. The Reserve Bank of India (RBI) has played a crucial role, raising the policy repo rate by 250 basis points since May 2022. This has nudged the weighted average domestic term deposit rate (WADTDR) upward, making deposits more appealing to savers.
However, the landscape is not without its challenges. Fitch Ratings has raised concerns about the long-term funding mix of Indian banks. The agency predicts a gradual increase in the share of borrowings within the overall funding mix. Currently, borrowings account for about 10% of the mix. If banks cannot attract sufficient low-cost long-term resources, funding costs will inevitably rise.
The shift from low-cost deposits to term deposits is a common reaction to high interest rates. Yet, the share of low-cost deposits has plummeted to a two-decade low of 20% in FY24. This trend poses a risk. If deposit growth continues to lag behind loan growth, the loan-to-deposit ratio (LDR) could remain elevated, leading to structural issues within the banking system.
The data paints a stark picture. Between FY14 and FY24, deposit growth matched loan growth at a compounded annual growth rate (CAGR) of 9.4%. However, since FY21, the LDR has surged by 10 percentage points. This imbalance raises alarms about the sustainability of current deposit pricing strategies. If banks are to support the economy's reliance on credit, they must focus on growing deposits.
Fitch’s analysis indicates that the current deposit pricing strategy may not hold up in the long run. The agency does not foresee immediate pressure on banks' viability ratings, but warns that individual key rating factors may need reassessment if margins, growth, and liquidity management are adversely affected.
Moreover, the rise of mutual funds (MFs) presents another challenge. Since FY17, MF investments have grown at a staggering 24% CAGR. As capital markets perform well, retail savings are increasingly shifting away from traditional bank deposits. Demographic changes and the rise of digital banking are accelerating this trend.
Fitch suggests that a broader depositor base beyond the top 15 urban centers could bolster inflows and enhance deposit retention. Currently, these urban centers account for 65% of MF assets and 44% of bank deposits. Expanding the depositor base could be a lifeline for banks struggling to maintain their deposit growth.
The pressure on margins is palpable. A continued rise in the LDR could exacerbate margin pressures beyond expectations. Indian banks have limited pricing power, which hampers their ability to fully pass on increased funding costs. This situation may compel banks to take on additional risks to maintain profitability.
Liquidity management is another critical area of concern. The RBI's liquidity stance and government-linked inflows could alleviate some pressure, as seen in the past. However, declining flows due to lower real returns on deposits could heighten the strain on LDR and asset-liability management.
In summary, Indian banks are at a crossroads. The recent surge in deposits is a welcome development, but it masks underlying challenges. The shift in depositor behavior, rising funding costs, and the growing prominence of mutual funds complicate the landscape. Banks must adapt swiftly to these changes. They need to innovate their deposit strategies and enhance their appeal to a broader range of depositors.
The road ahead is fraught with challenges, but it also presents opportunities. By embracing change and focusing on sustainable growth, Indian banks can navigate this complex terrain. The future of banking in India hinges on their ability to balance deposit growth with credit demand, ensuring stability in an ever-evolving financial ecosystem.