Deposit-Lending Gap in Indian Banks

Source-This post on Deposit-Lending Gap in Indian Banks has been created based on the article “Bank deposit shortage: Could a role shift work?” published in “Live Mint” on 13 August 2024.

UPSC Syllabus-GS Paper-3- Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context– Indian regulators are urging banks to increase deposits because they are currently falling behind in comparison to lending growth. If this gap continues, banks may face higher costs for funding or may reduce lending, which could slow down economic growth.

The Finance Minister, RBI Governor, and the Economic Survey have all expressed concerns. For instance, in 2023, credit grew by 16%, but deposits increased by only 13%. This gap has been larger in recent years, with a brief exception during the pandemic when deposit growth surged.

What are the factors contributing to the decline in bank deposits?

1) Low Interest Rates– Long periods of low deposit rates discouraged savers as they began to focus on ‘real’ returns after inflation. Frustrated by these low rates, many households shifted their savings to the stock market. This was driven by a strong bull market and user-friendly mobile trading apps.

2) Tax Regime- Previously, the tax system favored debt funds over bank deposits with benefits like indexation and lower taxes on long-term gains. In 2023, this was fixed by taxing debt fund earnings at the same rate as bank deposit interest. However, no new measures have been introduced to make bank deposits more attractive.

3) Changing Saver Demographics– Experienced savers are pursuing higher returns through investments, but the growth in new savers is insufficient to satisfy banks’ requirements.

4) Diminished Role of Banks- The growth of capital markets, which allow direct funding through bonds and shares, may be diminishing the traditional role of banks as financial intermediaries.

Read More- Status of Non-Performing Assets (NPAs) – Explained, pointwise

What should be the way forward?

1) Tax Relief on Bank Deposits -Eliminating the tax on interest from bank deposits could motivate people to save in traditional bank accounts by providing better returns and more favorable terms.

2) Centralizing Deposits to Enhance Bank Stability -Centralizing public deposits with the RBI would allow banks to focus on lending and risk management. Depositors could keep their money with the RBI, which would offer slightly lower interest rates for greater security. The RBI could then lend these funds to banks at special rates, supporting their lending and ensuring financial stability.

Question for practice

What are the factors contributing to the decline in bank deposits?