When Deposits Become 'ASSETS' For Banks

My neighbour Mr Fernandez has resumed his habit of visiting bank branches. A super senior citizen, he earlier used to visit the branches often. But he stopped as branch staff started hounding him, selling mutual funds and insurance policies.

He has kept his money with two banks – a private and a public-sector bank. The “treatment” was the same at both banks.

Last month, the relationship manager of one bank dropped by Mr Fernandez’s house. She convinced him to open a fat fixed deposit (FD) with the bank as a large amount in his savings bank account was earning very low interest. She also promised that Mr Fernandez would no longer be “harassed” if he decided to visit the branch.

She didn’t lie. The first branch visit after a gap of three years was a pleasant surprise for Mr Fernandez. The branch manager ushered him into his glass cabin and offered him a cup of coffee. Instead of selling him mutual funds and insurance policies, he floated the idea of opening another FD for a higher return.

The branch manager also suggested that Mr Fernandez opt for a sweep-in facility. Such a facility ensures whenever funds in his savings account drop below a certain level, money will flow from the FD to his savings account without affecting the interest rate on his fixed deposit.

Banks are desperately looking for deposits as high credit deposit (CD) ratio is staring at them. Until this phenomenon had hit them, they were happy earning commission and fee income, aggressively selling mutual funds and insurance products. Now, they have reached a stage where they need to choose between fee income and interest income. (Of course, they can always earn processing fees from loans.)

They can’t afford to win away depositors’ money into these avenues any more as their credit growth will be affected, with deposits failing to meet the credit demand. This will also bring down their interest income.

Banking is the only business in the world where raw material and finished products are the same – only packaging changes.

Lime, silica, alumina, calcium sulphate, iron oxide, magnesia, sulphur trioxide, soda and potash are used to produce cement. Similarly, the ingredients for making a pizza are flour, yeast, mozzarella cheese, white sugar, tomatoes, onion and olive oil. But banking is not a pizza. It’s about taking Mr Fernandez’s money as deposit and passing it to, say, Mr Tripathy, as a loan. Money could be kept in savings accounts, fixed deposits or recurring deposits and the loan could be a home loan, auto loan, personal loan or working capital and term loan (for corporations), but the ingredient remains the same – money.

On a bank’s balance sheet, the deposits are placed on the left side and loans and investments on the right. The deposits are a bank’s liability and loans and investments are assets.

Mobilisation of deposits is not easy as depositors run the risk of losing money if a bank fails (up to ~5 lakh worth of deposits enjoy an insurance cover). Choosing the borrowers is equally tough; if a borrower does not pay up, a loan turns bad, and the bank needs to provide for it. This affects a bank’s profitability and capital.

Even after giving a loan, a bank needs to keep a hawk eye on the borrower to make sure that the account doesn’t turn bad. In contrast, once a depositor is in, nothing needs to be done till an FD is due for renewal.

For every Rs100 worth of deposits, banks need to keep Rs4.50 with the Reserve Bank of India (RBI) under the cash reserve ratio requirement. Another Rs18 is spent on buying government bonds under the statutory liquidity ratio requirement. This means, they are left with Rs77.50 to lend for every Rs100 worth of deposits. That’s not exactly the case as most banks invest far more in government bonds. Besides, depending on the profile of the liabilities, they also need to keep additional 3-4 per cent of deposits under liquidity coverage ratio requirements. Of course, they use their capital too to lend.

In FY24, banks’ CD ratio rose from 75.8 per cent to 80.3 per cent, the highest level since FY05. It had been hovering around 80 per cent since September 2023 before the recent downward movement. In fact, in March this year, the incremental CD ratio was 95.94 per cent.

As on October 4, year-on-year credit growth had been 12.8 per cent and deposit growth 11.8 per cent -- leaving a gap of 1 percentage point. At the beginning of the current financial year (on April 5), year-on-year credit growth was 19.9 per cent vs 13.8 per cent deposit growth – a gap of 6.1 percentage points. (Of course, they are not exactly comparable as the base of the credit portfolio is lower than the deposit portfolio.)

Many reasons have been cited for the low growth in deposits.

The most prominent among them is that the community of savers has become investor. Instead of keeping money with banks, they are investing in the stock market – buying equity directly as well as putting money in mutual funds. The counter argument is: The money ultimately comes to the system. Instead of coming from individual savers, it is flowing through a different route. Of course, the cost of such money and maturity and tags are different from deposits.

Another reason is that a large segment of the population does not have money to keep in banks. India's household savings as a percentage of gross domestic product (GDP) has declined from 22.7 per cent in 2021 to 18.4 per cent in 2023. This is a 47-year low.

The theory that every credit creates new deposits may not always work, particularly if the money raised as a bank loan is used for investing in the stock market.

Everyone agrees on one issue: The cash management by the government – both at the central and state levels – has affected banks. Instead of keeping money with banks, the governments are now keeping money with the RBI. Particularly during the general elections, the government’s cash balance with the regulator was huge.

Bankers feel that their hands are tied and they cannot fight with mutual funds. Typically, the return from mutual funds is higher than bank deposits. On top of that, there’s tax advantage on such returns while interest income on bank deposits is taxable (depending on the customer’s annual income) -- even before it is realised. If one keeps a two-year FD, the tax clock starts ticking from the first quarter itself, even though the FD will mature after two years. This is not the case with mutual fund returns.

What can banks do to raise deposits? The easiest solution is raising the interest rate. But this will impact their profitability as they will not be able to raise loan rates when the policy rate is set to go down.

It’s time for banks to innovate. State Bank of India has spoken about targeting trusts, societies, associations and clubs as well as the Jan Dhan accounts for deposits. Another bank has introduced a liquid product – one can withdraw money after seven days but earns the FD rate. And many banks are planning to expand their branch network to reach out to more people for deposits.

After the savings bank rate was deregulated in 2011, a few private banks experimented with savings bank products. When it comes to FDs, we have not seen innovation, barring floating-rate FDs, which never took off. It’s time to innovate. Depositors are not the liability of the banking system; they are the real assets.

The financial system should also prepare itself for structural changes. In most developed nations, corporations source money from the market, not banks. This means we need a more vibrant corporate bond market. That’s a separate story.

This column first appeared in Business Standard.

The writer is a Consulting Editor with Business Standard and Senior Adviser to Jana Small Finance Bank.

Writes Banker's Trust every Monday in Business Standard.

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