Stagnant household bank deposits cast shadow on credit growth

The impact of policy hikes on deposit rates has been relatively modest in FY23 but is catching up rapidly. (Representative image)

Last June, I anticipated an imminent clash for deposits within the banking system. As the fiscal year 2023 drew to a close, this clash unfolded in full force, with banks engaging in fierce competition to attract deposits, especially as credit growth remained robust. A notable disparity had emerged between the rates of credit and deposit growth in the second half of calendar year 2022; credit expanded at around 18 percent, while deposit growth languished at around 8 percent. Subsequently, the gap between credit and deposit growth has narrowed, with credit now growing at over 15 percent and deposits at approximately 12 percent resulting in decreasing credit-deposit ratio for the banking system. The deceleration in credit growth can be attributed to the transmission of policy rate hikes, which have made borrowing more expensive. Conversely, the impact of policy hikes on deposit rates has been relatively modest in FY23 but is catching up rapidly, particularly in term deposits. Recent data from the Reserve Bank of India (RBI) sheds light on deposit patterns in India, providing insights into the disparity between deposit and credit growth and raising concerns about sustaining credit growth in the future.

Household Deposits Stagnate

Approximately 60 percent share of total deposits in Indian banks are attributed to household savings, while the remaining share is held by private corporations, governments and government-owned entities, and others. Recent data reveals that the contribution of households to deposits has stagnated, and the growth in the banking system's deposits can be attributed mainly to the expansion of private corporate deposits. It is worth noting that the low deposit growth is not a recent occurrence; it has been on a declining trend since 2008. After the spike in bank deposits in 2016 following demonetisation, deposit growth has stagnated at a single-digit level due to minimal or no growth in households' deposits. The 15 percent growth in deposit balances for private corporations in FY23 can be understood considering the record profitability levels Indian companies have experienced post-pandemic. Furthermore, the deleveraging cycle corporations underwent between 2016 and 2020 has resulted in peak corporate savings.

However, the stagnation in household savings, despite robust economic growth, is both intriguing and concerning. Understanding the dynamics of household banking deposits is challenging due to limited granular and segmented data in the public domain. However, based on anecdotal evidence, a conjecture can be made. When examining the income pyramid of Indian households, it becomes evident that the bottom seven deciles have minimal participation in the banking system, contributing little to deposits and primarily relying on microfinance mechanisms for borrowing. The bulk of deposits are provided by the top two deciles, and within this segment, approximately three-fourths of households (ranging from around the 80th to the 95th percentile) have significantly increased their leverage in the past decade. Consumer credit from banks has quadrupled between 2014 and 2023, reaching nearly Rs 41 trillion, in addition to around Rs 7 trillion of consumer credit provided indirectly through non-banking finance companies (NBFCs). This growth in consumer credit surpassed the overall banking credit growth of approximately 9.5 percent in the same period. However, this credit is concentrated in a small segment of Indian households—the same segment that has been contributing to households' bank deposits.

Inflation Impact

Consequently, the gap between gross savings (income minus expenditure) and net savings (gross savings minus loan repayments) for these households has widened. Recent inflationary pressures suggest an increase in the cost of living, impacting gross household savings. The sharp rise in policy rates (250 basis points) has been substantially transmitted to consumer credit, especially home loans, which comprise about 55 percent of the total consumer credit, reducing households' net savings. Moreover, households' inclination to invest in alternatives to bank deposits, particularly mutual funds as evidenced by strong systematic investment plan (SIP) inflows, has contributed to the reduction in household savings held in bank deposits (although these inflows ultimately return to the banking system primarily as corporate deposits). The combined effect of these factors, one can surmise, has led to the stagnation of household inflows into bank deposits. If this trend persists, concerns arise regarding the continued disparity between deposit and credit growth, which could impede banks' ability to provide credit.

It is highly likely that corporate profitability will moderate to lower levels as the sharp rise in inflation permeates into costs. If long-overdue investment cycles return, corporate net savings are bound to decrease. Consequently, the buoyancy of corporate contributions to banking deposits will inevitably decline. Restoring growth in household savings held in bank deposits becomes crucial for the sustainability of banking credit. Increasing deposit pricing will be a significant factor in attracting inflows from households. However, the persistent (over)leveraging of segments contributing to deposits will hinder the growth of net savings. If inflation sustains at high levels, eroding gross savings, an increase in delinquencies within the consumer segment may eventually occur. The recent cautionary message from the RBI regarding unsecured credit is timely and is expected to encourage banks and non-banking financial institutions, especially fintech firms, to exercise prudence in extending such credit.

In the financial year 2023, banking system credit outgrew deposits by about Rs 2 trillion. Such a wide gap between credit and deposit is unsustainable and would eventually lead to credit rationing. Achieving balance between credit and deposit growth rates is critical to ensuring the sustainability of the banking system, even if it leads to reduced bank margins. However, to attain this equilibrium, the banking system may need to curtail consumer credit while adjusting deposit pricing.

Harsh Vardhan is a management consultant and researcher based in Mumbai. He serves as an independent director on the board of Karur Vysya Bank. Views are personal, and do not represent the stand of this publication. Thanks to MB Mahesh of Kotak Institutional Equities for valuable discussions.