Indian banking faces structural limitations in raising resources but there’s no threat to stability now

As long as corporate capex and infrastructure financing demand are sluggish, banks will be hard pressed.

There may have been no policy surprises in the recent MPC but some of the RBI’s concerns on financial system stability are interesting because they raise some important questions for banks. One of them is about slowing deposit growth, especially under demand deposits which it worries may impair credit growth besides causing structural liquidity issues. Another is the worry over the continued growth in certain types of unsecured loans which it fears could have systemic stability implications.

Deposit slowdown appears to be recent with nearly all the top banks, including HDFC, SBI and ICICI experiencing flat growth in Q1 of the current year.

Deposit slowdown may not be linked to stock markets

Current accounts savings account (CASA) deposits were also slowing which had implications for their cost of funds as well. But the explanation that this was a result of savings being diverted to stock markets and alternate investments appears more anecdotal than anything. To be sure, there has been a sharp rise in derivatives trading with volumes of options on the Nifty 50 index averaging about $1.64 trillion a day surpassing the S&P 500’s $1.44 trillion volume.

But to believe this came at the cost of savings deposits is a bit of a stretch. For one, options require only modest outlays given the high leverage available. Also, mutual fund investments have been growing more on the back of SIP strategies. The possibility of unsecured personal credit, the RBI’s other worry, fuelling this activity cannot also be ruled out.

Liquidity round-tripping between banks, MFs, insurance companies and other players has long been a feature of our financial system and the RBI’s Financial Stability Report itself has data on interconnectedness which details the movement of liquidity. Thus, bank deposits lost to MFs often find their way back to banks as investments into certificate of deposits or into commercial paper of NBFCs.

Reason for high CASA ratios

While deposits are their principal resources, it is hard to tell if a first quarter dip will impair credit growth.  The slowing of demand deposits will have some implication for margins. The high CASA ratio (over 40 percent) itself needs some explaining; it comes from the huge role that banks play as payments facilitators as also the growth of financial inclusion. Nearly 80 percent of payments in India pass through banks in the form of NEFT/IMPS/UPI and others. In the USA, cards dominate with 75 percent of all payments and bank checking accounts are only about 22 percent of liabilities.

The stickiness of demand deposits in India perhaps is more a function of the transaction demand for money than interest-rate movements. Payments data show that UPI transactions grew from Rs.14.9 trillion in May 2023 to over Rs.20.4 trillion in May 2024, a staggering 37 percent increase all of which pass through savings and current accounts.

Flip side of high CASA ratio

A high CASA ratio has been seen as desirable as it keeps cost of funds low and is also generally a stable source funds. On the flip side, it restricts their ability to lend long.

Asset liability profile data of banks show a pronounced working-capital credit tilt, with 30 percent of outstanding credit at less than 1 year and another 48 percent between 1 and 5 years, clearly coming from their deposit mix (37 percent deposits under 1 year, 25 percent between 1 and 3 years).

As long as corporate capex and infrastructure financing demand are sluggish, this will not matter but when they do revive, banks will be hard pressed. If we recall, banks’ previous foray into industrial and infrastructure financing had left behind a large NPA stockpile in part due to their inability to offer long-dated credit.

Maturity transformation has not really worked due to the lack of deep and vibrant secondary debt markets. A limited set of players and the pre-emption of a large part of savings by government (through banks, insurance and small savings) have meant that the supply of long-term funds, both for banks and corporates, was limited. With such structural issues, expecting banks to diversify their resource base is a tall ask.

Unsecured personal credit growth worries overstated

The other concern of the RBI is about the relentless growth in unsecured personal credit mainly credit cards and general-purpose consumption loans. A 23 percent growth in credit card debt despite high interest rates leaves it worried that a bubble could be building. But data show that outstanding card debt is still small (average outstanding debt Rs 2.5 lakh crore) though credit card transaction volumes have been high (average Rs. 17 lakh crore per year) and growing. What the data imply is an average card debt tenor of about 50 days which approximates the free credit period in most cards, suggesting that most users do not avail credit beyond the free limit. This could also explain why high rates of interest did not deter demand.

Besides mandates and regulations, what generally drives the direction of credit is risk appetite, demand and the resource mix. Personal credit seems to have ticked all the boxes, with unsecured lending offering the added prospect of higher returns. But the real test, in terms of both funding and asset quality, will come when corporate investment revives or when infrastructure projects shift from government funding to banks.