What FM Sitharaman’s warning means for banks

With credit growth outpacing deposits since FY 2022, the banking sector faces rising liquidity and credit risks.

Finance Minister Nirmala Sitharaman, during post-Union Budget consultations with finance ministry officials, remarked that deposits and lending are the two wheels of a cart, but deposits are moving slowly. She expressed concern over the sluggish growth of deposits compared to the growth of credit. The finance minister urged banks to focus more on their core functions: accepting deposits and providing loans to businesses and households.

In another meeting to review the performance of public sector banks (PSBs), she encouraged them to conduct special drives to garner deposits. Reserve Bank of India Governor Shakthikanta Das has flagged concerns multiple times in the recent past, including at the bi-monthly monetary policy meeting, about the mismatch in the growth of deposits and loans.

He cautioned the banks that raising funds through the issuance of certificates of deposit and other instruments to fund credit needs could expose the banking system to structural liquidity issues. He also encouraged banks to mobilise financial savings through innovative products and services by leveraging their extensive branch networks.

Starting from financial year 2022, bank credit growth has outpaced deposit growth, with the gap reaching as high as 7 per cent at the beginning of the year. The growth in credit has recently moderated. The credit deposit ratio, or CD ratio, was at 80 per cent in March 2024, which was the highest since 2015. A high CD ratio indicates credit and liquidity risks for banks.

To put this into perspective, banks have to keep aside 4.5 per cent of their deposits as cash reserve ratio (CRR) and a further 18 per cent as statutory reserve ratio, which means banks can lend a maximum of 77.5 per cent of their deposits. Additionally, banks must keep sufficient cash on hand to meet the needs of their savings and current account holders. So, the ideal CD ratio for banks should be around 75 per cent. Banks have two options to fix this anomaly: either increase the total deposits or cut back on loans.

On the deposit front, banks are launching special deposit schemes, offering high interest rates, and engaging in a war with each other for deposits to attract customers. Households have not been particularly enthused by the hike in interest rates since they are moving their savings towards riskier products such as mutual funds, cryptocurrencies, and portfolio management schemes. Within the deposit mix, money has moved from savings accounts to fixed deposits since interest rates on savings accounts have remained sticky around 3.5–4 per cent.

The total deposits of banks have grown at a compounded annual growth rate (CAGR) of 9.5 per cent since 2016 and doubled from Rs 100 lakh crore to Rs 210 lakh crore today. The total credit or loans given by banks, on the other hand, has grown at a CAGR of 12.50 per cent from Rs 66 lakh crore to Rs 169 lakh crore during the same period. The RBI has cautioned banks to go slow on lending to personal loans and non-banking finance corporations (NBFCs)—the latter because of the potential systemic shocks if any of them were to collapse. Banks’ credit growth in these segments has already moderated.

What happens if banks do not offer innovative products but instead increase FD rates by 50 to 100 basis points while lending rates remain unchanged? This will lead to a compression of net interest margins (NIMs) and impact the profitability of banks. The coming quarters would reflect the pressure on the bottom line of banks, more so on the PSBs since they don’t focus as aggressively on fee-based income as their private sector counterparts.

Banks haven’t realised the weakness of the ‘same size fits all’ approach to mobilising deposits. For example, a particular variant of savings bank or current account may offer free chequebooks, a reduction in locker rent, free movie tickets, discounts in select restaurants, a couple of free lounge facilities at airports, cash deposits up to a certain level, and no charges on demand drafts or remittances such as NEFT and RTGS.

A depositor may not be interested in any of these features at all. Perhaps the finance minister was referring to this aspect when she mentioned innovative products. Banks need to design customised, not standardised, products. They need to treat customers differently and offer differential interest rates. The CASA (current account savings account) segment, which is highly sought-after by banks, needs a paradigm shift.

For example, banks could consider paying interest on current accounts beyond a certain threshold. Although banks have had a good run in recent years and have cleaned up their balance sheets, the recent trends in deposit growth indicate that they cannot afford to relax. Banks must prioritise innovation in their product offerings.

(The writer is a CFA and former banker)