How Banks Can Adapt to New Savings Trends

Source: The post How Banks Can Adapt to New Savings Trends has been created, based on the article “The recent deposit shortfall is a wake-up call for banks in India” published in “Live mint” on 31st December 2024

UPSC Syllabus Topic: GS Paper3- Economy- growth and development

Context: The article discusses how banks have experienced periods where credit growth exceeded deposit growth. Recently, this issue has not improved because credit growth fell without a rise in deposit growth, hinting at deeper changes in how people save. It critiques the assumption that a lack of deposits hinders credit growth and suggests that banks should update their financial practices and better reward depositors to adapt to changing economic behaviors.

For detailed information on Concerns related to savings in India read this article here

What is the Issue with Deposit and Credit Growth?

1. Between April 2022 and October 2024, there was a sixth occurrence where deposit growth was slower than credit growth.
2. Unlike previous instances where adjustments in both deposits and credits rectified imbalances, this time, the issue persisted due to declining credit growth without any increase in deposit growth.

Why Does a Deposit Crunch Not Hinder Credit Growth?

1. Contrary to popular belief, a deposit crunch does not prevent credit growth. It only raises the cost of funds for banks.
2. During 2004-2007, even with higher credit growth compared to deposit growth, banks managed well because they could pass the increased costs to retail borrowers more easily than to commercial ones.

What is Financial Repression?

1. Financial repression refers to the scenario where savers receive returns below inflation, leading to negative real interest rates.
2. This has historically helped fund cheap credits for businesses and governments.
3. Even in market-driven economies like the U.S., such strategies were used post-World War II and during the COVID-19 pandemic.

How Have Savers’ Behaviors Changed?

1. Between 2013 and 2023, the proportion of household financial assets to GDP rose from 41% to 46%.
2. More significantly, the portion of these assets kept in deposits and currency fell from 67% to 45%.
3. This shift indicates that households are diversifying away from traditional bank deposits, influenced by maturing capital markets and digital finance options.

What Can Banks Do Differently?

1. Banks need to revise how they evaluate the performance of their business units.
2. The current fund transfer pricing system might skew the perceived profitability of lending-focused units over those focused on raising deposits.
3. A more balanced approach considering the real cost of funds and rewarding deposit-raising efforts fairly could help.
4. Additionally, employing analytics to set competitive deposit rates might retain loyal customers and address rising funding costs.

Question for practice:

Discuss how changing economic behaviors and financial practices could impact banks’ approaches to managing deposit and credit growth?