The Deposit Crunch in Indian Banking

Source-This post on The Deposit Crunch in Indian Banking has been created based on the article “With worst deposit crunch in 20 years, five banking issues to address” published in “The Indian Express” on 16 August 2024.

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

Context-The Indian banking sector is currently facing its most severe deposit crunch in two decades, characterized by a widening gap between bank deposits and credit growth. This situation has raised concerns among experts and policymakers alike.

Banks heavily rely on current and savings accounts (CASA) as a primary source of funding. These accounts are low-cost and represent a stable portion of total deposits. Presently, CASA deposits account for 41% of total bank deposits, a slight decrease from 43% the previous year.

What are the Disruptive Forces in the Banking Sector?

1) Increased Competition: Banks face growing competition from non-traditional financial entities.

2) Technological Advances: Innovations have transformed banking operations and customer expectations.

3) Deregulation: The easing of regulations has intensified competitive pressures.

4) Changing Saver Preferences – In India, savers have accepted low returns on bank deposits due to high inflation, with deposits yielding 3-5% while inflation averaged 6.6%. Now, with better investment options available, savers are shifting away from deposits, challenging banks’ high-interest margins.

Read More- Deposit-Lending Gap in Indian Banks

What are the economic implications of deposit crunch?

1) Core deposits are crucial as they provide a stable funding base, shielding banks from fluctuations in market rates. A reduced share of core deposits means banks must turn to more expensive sources of funding, impacting their profit margins.

2) The deposit shortage can affect the wider economy, as banks may become less able or willing to provide loans due to higher liquidity risks.

3) Borrowers who rely on bank financing may struggle to get funds or face higher borrowing costs. This could limit their ability to invest, which may negatively impact the overall economy.

4) The deposit crunch could affect credit flow to NBFCs, microfinance institutions, and smaller lenders. This can harm both consumer spending and investment activities.

What are the Key Questions and Considerations?

1) Impact on Loan Growth– The link between deposit growth and loan growth is complex. Banks usually need new deposits to boost loan growth and look for lending opportunities as their deposits increase. Evidence shows that these two factors are closely connected.

2) Extent of Deposit Decline– The decline in deposit growth affects all banks, including major public and private sector institutions. This is evident from their financial results and management discussions.

3) Variation Across Loan Portfolios- The effect of slower deposit growth differs by loan type. Retail loan demand is still strong, but industrial demand hasn’t increased much. If industry demand grows beyond short-term needs, the deposit shortage could hurt economic activity.

Way ahead– Banks need to offer better options for savers and control expenses. This underscores the need for policymakers to focus on expanding the bond markets. Policy implications.

Question for practice

What are the economic implications of deposit crunch?