Indian Banks Face Pressure to Borrow More as Deposit Growth Slows

Indian Banks Face Pressure to Borrow More as Deposit Growth Slows

A Fitch Ratings report highlights that Indian banks may increasingly rely on borrowing to support loan growth due to a slowdown in deposit growth and a decline in the share of low-cost deposits. The report notes that if banks struggle to attract fresh deposits, their borrowings will rise gradually within the overall funding mix.

The surge in the loan-to-deposit ratio (LDR) poses potential structural challenges, especially if low deposit returns and changing depositor preferences hinder long-term deposit growth. Despite a sharp 250 basis point increase in policy rates during the financial year ended March 2023, deposit rates have been slow to adjust, with term deposit rates only reflecting these changes as of the first quarter of FY25. The share of low-cost deposits has dropped to a two-decade low of 20% in FY24.

Factors such as inflation, increasing digitalization, and strong performance in capital markets may drive depositors to shift their funds from bank deposits to investments. This trend could put additional pressure on banks' funding costs and complicate asset-liability management.

Fitch does not foresee immediate rating changes due to the current situation, as banks maintain adequate headroom in their Viability Ratings. However, significant funding changes that intensify margin pressures may prompt a reevaluation of key rating factors.

Since March 2022, term deposit rates have risen by 234 basis points, while low-cost deposit rates have remained unchanged. The report warns that the ongoing increase in the LDR may persist as a structural issue if deposit growth continues to be constrained by low real returns and evolving depositor preferences.

While deposit growth has historically matched loan growth at a 9.4% compound annual growth rate (CAGR) from FY14 to FY24, the LDR has increased by 10 percentage points since FY21. Fitch emphasizes the necessity for banks to focus on deposit growth to address previous liquidity excesses.

Mutual fund investments have also surged, growing at a 24% CAGR since FY17, which may further accelerate the shift of retail savings towards investments. The report notes that demographic changes and digital advancements could contribute to the movement away from bank deposits. A continued rise in the LDR could exacerbate margin pressures for banks, which have limited pricing power to fully pass on increased funding costs without additional risk.