This is a new headache as households are parking their money more in the stock market than in bank deposit schemes
Sajjad Bazaz
Prime Minister Narendra Modi in his Independence Day speech on August 15 hailed the country’s banking sector reforms, adding that Indian banks “now count among the strongest in world”. He stated that the banking sector in the pre-2014 era was in bad shape as “there was no growth, no expansion, and there was no faith (in the banking system)”.
The statement of the Prime Minister must necessarily be based on the facts and figures depicting the growth story of the banking sector in the last 10 years of the NDA rule. But it is also a fact that despite this growth, the worries in the banking sector have also grown exponentially. The pace at which banks have diversified their operational activities in the name of garnering more and more business as one-stop financial shops during the last one decade seems to have been boomeranging. To be precise, banks during the last ten years have lost their love for core banking. So despite recording growth and expansion in their reach, banks continue to face difficult times at the moment for the lack of sufficient prime resources required to create assets.
When we talk of core banking, it means collecting deposits and extending loans and advances, precisely lending money to various sectors of the economy. The banks’ ability to collect and retain deposits bears a big question mark. Today, there is a worrisome mismatch in deposits and lending. The gap between the two has been widening consistently. The latest RBI data reveals that the deposit growth of commercial banks declined to 10.64% for the fortnight ending June 28 while credit increased at 13.88% year-on-year.
Even as there will always be some gap between the deposits and the loan portfolio of the banks, the credit (loan) growth should not outpace deposit growth by a great amount. If we go by the rule book, banks are required to maintain CRR (cash reserve ratio), SLR (statutory liquidity ratio), LCR (liquidity coverage ratio), etc. out of their total deposits to meet any eventuality.
The intensity of issue arising out of the banks’ poor deposit mobilization can be gauged from the fact that the finance minister Nirmala Sitharaman and the Reserve Bank of India (RBI) Governor at a post-Budget meeting on August 10 expressed their displeasure over the lack of banks’ focus on ‘core banking’.
While underscoring the need for banks to concentrate on their fundamental operations, the government and RBI have been telling banks continuously to focus on core banking, including deposit collection and lending money. In order to overcome the mismatch between deposits and lending, banks have been asked to come up with “innovative and attractive” deposit schemes to mobilise funds from the people.
Notably, household savings hold key when it comes to mobilization of deposits by banks. Even as the financial assets owned by households constitute a major (dominant) percentage of bank deposits, their share has been continuously declining. The reason has been that the households are increasingly investing their savings in capital markets and other financial intermediaries.
Here the June edition of RBI’s Financial Stability Report is worth quoting, India’s overall household savings declined to 18.4% of GDP in the financial year 2022-23 from an average of 20% during 2013-2022. The share of net financial savings in total household savings fell to 28.5% in 2022-23, from an average of 39.8% during 2013-2022.
Why are deposits important for banks? Basically deposits form the foundation of the banking system. These are crucial for banks as the money collected through various deposit schemes acts as a stream providing a stable and low-cost source of funds. These funds are essential for granting loans to various sectors of economy and maintaining liquidity. Higher the deposit levels, more funds remain available with banks to offer competitive interest rates on loans, support their operational needs and meet regulatory requirements. When deposit levels drop, banks are hit with reduced capacity to lend, have to rely more on expensive sources to generate funds and face potential liquidity issues. In the long run, a low deposit level undermines a bank’s financial stability and growth prospects. Amid the low deposit growth, the lending squeezes net interest margin (NIM) as the cost of funds increases.
In the given scenario, the banks have been taking greater recourse to short-term non-retail deposits and other instruments of liability to meet the incremental credit demand. The RBI Governor Shaktikanta Das has already warned that the situation may potentially expose the banking system to structural liquidity issues.
Structural liquidity risk is a material risk resulting from the core banking business of taking in short-term deposits and lending out long-term loans. This situation results in a maturity mismatch between assets and liabilities. There will be a time when the long-term loans will require refinancing and at this point of time the banks/financial institution is at risk of an adverse development of refinancing costs.
Actually, the household sector plays a crucial role in the Indian economy, contributing significantly to the total gross domestic savings. Traditionally speaking, households have always relied on various bank deposit schemes for their savings owing to their perceived safety and stability. Stock market volatility and complexity was not matching their risk bearing capacity.
However, over a period of time and with the advent of advanced technology, we observed an unprecedented shift in the bank depositors, especially the young ones, behaviour and have been boarding the capital market platform. They have been gladly taking some risk by investing in the stock market and diversifying their portfolios beyond traditional bank deposit schemes.
The household and other retail investors’ evergreen participation in the Indian financial market reflects their growing interest and confidence in the equity market. This surge is evident through the significant rise in demat accounts and robust inflows into mutual funds. Here it is the same amount of money which used to be parked in bank deposit schemes.
Notably, despite the geopolitical tensions, the resilience of the Indian stock market has been remarkable, and this ability to withstand extremely unfavourable conditions has been encouraging more investors to invest in the stock market. A record 32 million demat accounts were opened in FY24, with 10 million added in the last quarter (Q4 FY24). According to a recent report by domestic brokerage firm Motilal Oswal, the total number of demat accounts surged to a record high of 154 million by the end of April 2024.
What are the factors responsible for low growth level of bank deposits? Honestly speaking, banks cannot say that the customers (depositors) are not loyal to them. In fact, depositors have a right to explore avenues where they can earn maximum returns on their investment. So, dismal savings rates and poor transmission of policy rates by banks contribute to their depleting deposit levels.
otably, experts point to the growing disparity between interest rates on term deposits and savings accounts as a key factor. While savings account rates hover around 3-3.5%, term deposits can offer interest rates as high as 7% to 7.75%.
The shift in investment preferences is driving this trend. Bankers point out that, with the attractive returns offered by Capital market investment in equities, mutual funds, tax-saving equity-linked savings schemes (ELSS) etc. is offering attractive returns than the bank deposit schemes, be it savings account scheme or term deposit schemes.
As per the economic survey 2023-24, individual (retail) investors have around Rs 36 lakh crore in direct equities and Rs 28 lakh crore in assets under management of mutual funds.
Individual investors are over 9.5 crore and have nearly 10% direct ownership of the market through its almost 2,500 listed companies.
Last but not the least. Banks are themselves responsible for facing a drought of deposits. They are busy counting fee-based income generated through the sale of third-party products such as mutual funds, insurance policies etc., but lose sight of their own retail (especially household) deposit portfolio.
They are extraordinarily pursuing and pushing their own customers into the purchase of third-party financial products. the customers use their bank deposits to stay invested in other financial instruments – be it capital market products or insurance policies.
So, if drought on deposits is to be arrested, the banks have to rethink the policy matters governing their sale of third=party products at the business outlets.
(The author is a former Head of Corporate Communication & CSR and Internal Communication & Knowledge Management Departments of J&K Bank).
