Primarily due to changes in the business model, the bank is facing the problem of declining deposit base today. The loan-deposit ratio has reached 80 percent, which is the highest level since 2015. The CD ratio explains, how much of the bank’s deposit base is being used for credit.
In the financial year 2023, bank deposit grew at a rate of 9.6 percent, while borrowing grew at a rate of 15.4 percent. According to the Reserve Bank of India, there has been a decrease of Rs.3.5 lakh crore in bank deposit from January 1 to June 14, 2024 of the current year as compared to last year, while credit has increased by 19 percent on a year-on-year basis. This figure shows the growing gap between credit and deposit.
Banks’ strategy of raising deposit rates to attract retail deposit is not working due to increasing competition, alternative investment options, growing trend towards investing in gold and real estate. With the economy continuing to remain strong, the stock market’s splendid performance and growing financial awareness, investors are being attracted to invest in the equity-linked products in the anticipation of higher returns.
As a result of the merger of HDFC and HDFC Bank, HDFC’s loans and deposit have now become a part of the banking system, which has also increased the gap in the overall credit-deposit ratio. The high credit-deposit ratio increases the dependence on high-cost deposit, as the bank’s core customers are currently not meeting the bank’s deposit needs, as the position of bank has gone down in their investment preference.
The basic principle of banking is to take deposit from customers and give credit to the needy and businessmen. There is always a need to maintain a balance between the deposit and credit. For earning profit, there must be a certain spread between deposit and credit’s interest rate. Mismatch or big gap in this is not good for the health of the bank.
Deposit and credit have equal importance in a bank, as without enough deposit base in the bank, credit outflows cannot boom, but for the last few years, banks have been neglecting deposit business. Banks presumed that deposits business will automatically keep increasing, nonetheless, today this is not happening.
Earlier, to increase deposit base, all banks used to provide higher interest on various deposit schemes as per strength of their balance sheet, so that their deposit base upsurges, but now, due to surge in deposit cost, pressure on net interest margin (NIM) is increasing and due to decrease in profit from NIM, the operating profit of banks is declining. Also, because of high outflow of deposit from banks, liquidity risk is arising in front of banks.
Another problem in this case is that despite the lack of low-priced deposit, banks want to increase the percentage of loan disbursement, on account of which the bank has to take deposit from the market at a higher cost and owing to the rise in the cost of deposit, banks are increasing the lending rate, which may diminish the borrowing level of the bank and may also lessen the profit of banks.
Banks have made a twofold mistake in the matter of deposit front. First, they stopped running attractive schemes to increase deposit base and second, bank deposit started being used to increase mutual fund and insurance business. Bank employees started luring customers with the promise of higher returns in mutual funds and insurance. By reason of this, customers started withdrawing from term and savings accounts and investing in mutual fund and insurance.
Over time, in order to collect more taxes or increase revenue collection, the government made interest on saving and recurring deposit taxable. Further, in the initial period, due to the availability of low-cost deposit in the bank. the interest rates on term deposit were reduced significantly by banks, in due course, as a result of which, customers started avoiding investing in various bank deposit schemes.
One reason for the deposit crunch is that banks set aside a portion of the deposit collected for regulatory requirements, such as cash reserve ratio (CRR) and statutory liquidity ratio (SLR), which has reduced the lendable amount of the bank. In recent quarters, banks had used their surplus SLR holdings to accelerate loan growth amid slow deposit growth, which led to a reduction in the SLR buffer and banks faced the challenge of balancing profitability as well as deposit rate hikes.
In recent years, the desire to earn money as quickly as possible has increased among the youth. The Indian economy remained strong during the Corona pandemic compared to the developed countries of the world, due to which the Sensex and Nifty also remained bullish and investors kept earning. Due to this, the number of people opening Demat accounts increased during the Corona period and thereafter. According to a report by the Securities and Exchange Board of India (SEBI), 1 crore 7 lakh Demat accounts were opened between April 2020 and January 2021, as buying and selling of shares in the stock market can be done only through a Demat account. By March 2024, the total number of Demat accounts in India reached a new high of 15 crore 10 lakh. About 30 lakhs new Demat accounts were opened in March 2024 alone.
At present, the cost of deposit is increasing, while the credit interest rate remains almost stable. This is continuously increasing pressure on NIM & net interest income (NII). Although, credit disbursement is expected to increase further, but the increasing cost of deposit remains a cause of concern for banks. In the June quarter of the current financial year, the NIM of banks is expected to decrease further, because due to the shortage of cash in banks as well as the continuous increase in the demand for deposit, the NII of banks is expected to decrease by 4.8 percent and net profit by 6 percent on quarterly basis.
Reserve Bank of India’s Governor Shri Shakti Kant Das has expressed concern over the increasing gap between credit and deposit in the recently concluded meeting of the heads of private and public sector banks. Along with this, he has also advised the boards of banks to reconsider the existing business model of the bank. In such a situation, banks need to discuss the relevance of their existing business model and they will have to refrain from making a dent in their deposit base to increase mutual fund and insurance business. Also, banks will have to offer attractive interest rates to customers to increase deposits, which will upsurge pressure on net NIM & NII, but this pressure can be reduced a little by accelerating credit disbursal and increasing other income.
Satish Singh, Ahmedabad based Senior Columnist. Views are Personal
