Banking Central | How banks can check the flight of funds and get savers back

Banks need to make deposits attratcive to get back savers

Ratings agency Fitch has just flagged concern over the flight of deposits from banks to various other investment avenues. Inflationary headwinds, ease of transaction in digital mode, and strong capital-market performance may further drive funds away from the lenders, it said.

This trend poses a risk to funding costs and may render asset-liability management more challenging if banks’ long-term funding does not plug the gap from any migrating deposits, the agency said. Fitch on October 17 merely resonated worries the Reserve Bank has been voicing for some time, linking increasing digitalisation and ease of technology to the drift in bank deposits to other instruments.

The argument doesn't hold ground, though. Ease of transactions doesn't influence investment decisions beyond a point.

For an investor seeking returns to the investments, there is no incentive to park the money in bank fixed deposits at the moment. Smartphones apps may help one move the money from the bank account to mutual funds or to the stock market at just a few taps.

Unlike the old days when one had to visit the bank branch, stand in a queue for half an hour, and then go through tedious paperworks to break a bank FD, it's true that one can now simply close it with just a couple of taps on the smartphone app. The same device has other apps too through which one can instantly transfer the money to stocks or bonds. One can't deny that such technology has played a part in the flight of deposits.

But there's a flipside to it too that cannot be ignored. The same ease of technology enables an investor to plough back the money to bank deposits.

But that's not happening. And, why so? The answer lies in the poor returns that banks are offering on deposits. A two-year-maturity deposit, which typically offers highest interest rates, with large banks now offer 7-7.25

percent returns. After deduction of tax, this works out to around 5 percent and if you are sharp enough to look at the inflation-adjusted returns, then you can easily figure that you aren’t really earning much from the bank deposits. In fact, for the guarantee it offers, the price you are paying to the bank is really high for keeping your hard-earned money in the bank deposit.

What do the numbers say?

Banks are quick to increase lending rates whenever there is a slightest opportunity to do so, even for old customers. But, they are super conservative when it comes to raising the deposit rates.

How has the monetary transmission happened so far? The RBI bulletin for September gives a glimpse of how banks effected monetary transmission of the central bank rate actions in the current rate hike cycle that started around two years ago.

In response to the Reserve Bank of India rate hikes between May 2022 and August 2024 by a total of 250 basis points (bps), the marginal cost of lending rates (MCLR) of commercial was increased by 170 basis points (bps) during May 2022 to August 2024. One basis point is one hundredth of a percentage point.

Consequently, the weighted average lending rates (WALRs) on fresh and outstanding rupee loans increased by 189 bps and 119 bps between May 2022 and July 2024.  In other words, the response from the banks on lending rates shows the RBI rate hikes were not fully transmitted to the end-consumer.

In the case of repo-linked loans, logically, banks have revised upwards their repo-linked external benchmark-based lending rates (EBLRs) by a similar magnitude. On the deposit side, the weighted average domestic term deposit rates (WADTDRs) on fresh and outstanding rupee term deposits increased by 245 bps and 189 bps in this period.

Is there scope for further increase in deposits?

There is, in all likelihood. As Fitch rightly said, bank deposit rates have been slow to respond to a sharp 250-bp increase in policy rates in FY23, with term deposit rates to fully reflect this change as of 1QFY25. The return on low-cost deposits remains unchanged, leading to their share in new deposits hitting a two-decade low of 20 percent in FY24, according to Fitch estimates.

Banks will be forced to relook at their interest rates if they need to arrest the deposit exodus and forget interest margins for the time being in order to get the investor interest back in bank deposits.

A structural shift occurs when the investor-psyche is influenced by the thought that a particular instrument is not worth investing because of its poor performance for a considerably long period. Bank deposit rates need to be hiked by at least 1-2 percent to woo back the depositor. Else, they need to prepare for alternative borrowing sources to raise resources.

Fitch warns that the share of Indian banks' borrowings will continue to rise gradually within their overall funding mix if they struggle to attract sufficient fresh deposits to support loan growth.

The recent sharp rise in the loan-to-deposit ratio (LDR) could become a structural issue if low returns on deposits amid inflationary pressures - and evolving depositor preferences - hinder long-term deposit growth, the agency says. Banks should get the message.

Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.