Quarter-End Deposit Surge Temporarily Eases Pressure on Credit-Deposit Ratio, but Long-Term Challenges Persist

Quarter-End Deposit Surge Temporarily Eases Pressure on Credit-Deposit Ratio, but Long-Term Challenges Persist

A concerted push by Indian banks to mobilize deposits towards the end of the quarter helped reduce the rising credit-deposit ratio by 0.7 percentage points in the fortnight ending October 4, 2024. According to the latest figures released by the Reserve Bank of India (RBI), the credit-deposit ratio stood at 78.9% on October 4, down from 79.6% recorded on September 20. This temporary dip came as a result of increased efforts by banks to shore up deposits amidst ongoing concerns over the widening gap between credit growth and deposit mobilization.

Despite this short-term reprieve, the broader challenge of deposit growth lagging behind credit growth on a year-on-year (y-o-y) basis continues to persist. According to the RBI, year-on-year deposit growth has consistently been outpaced by credit expansion, leading to higher loan-deposit ratios across the banking sector. This disparity has raised concerns over liquidity management for banks, particularly as demand for loans surges ahead of the festive season, further straining the balance between credit disbursement and available deposit reserves.

The quarter-end deposit mobilization rush, which typically sees banks offer more competitive interest rates on fixed deposits and savings accounts to attract depositors, provided a much-needed cushion to the system. However, it did little to address the structural issues at play. Credit growth has been robust in recent quarters, spurred by rising demand for retail loans, including personal loans, home loans, and auto loans, as well as an increase in corporate borrowing.

Long-Term Imbalance in Credit and Deposit Growth

RBI data shows that credit growth in India has been expanding at a significantly faster pace than deposits, leading to concerns that banks may face liquidity pressures if this trend continues. As of the fortnight ending October 4, the year-on-year credit growth was approximately 15%, while deposit growth hovered around 9%, highlighting a substantial gap that has persisted for several months.

The credit-deposit ratio, a key indicator of a bank’s liquidity position, indicates how much of the banks’ funds, primarily sourced from customer deposits, are being lent out. A higher ratio suggests that banks are increasingly relying on their deposits to meet credit demand, which could expose them to liquidity risks, particularly in times of economic stress or if deposits fail to keep pace with rising credit demand.

Several factors have contributed to the sluggish deposit growth. One of the primary reasons is the growing preference among Indian consumers for higher-yielding investment options such as equity mutual funds, government bonds, and non-banking financial products, as opposed to traditional savings accounts and fixed deposits. Additionally, the prevailing high-interest rate environment has increased the cost of borrowing for banks, further complicating their ability to offer attractive deposit rates without eroding their profit margins.

Banking Sector Faces Continued Pressure on Margins

The banking sector has faced significant pressure on margins, with rising credit costs and difficulty in attracting deposits being recurring themes in recent earnings reports from leading banks. Banks with higher loan-deposit ratios, such as HDFC Bank, have been particularly impacted, as they are forced to rely on more expensive sources of funds, including market borrowings, to meet the growing demand for credit.

In response to these challenges, some banks have taken steps to moderate their loan growth, particularly in unsecured retail segments, in order to manage their credit-deposit ratios more effectively. Analysts at Jefferies noted that Indian lenders, especially those with high loan-deposit ratios, may be compelled to slow down their credit disbursements in the near term as they work to realign their deposit base with loan demand. This is particularly critical for banks like HDFC Bank, which reported a 5.1% quarter-on-quarter increase in deposits but continues to face pressures on profitability due to its elevated loan-deposit ratio.

The RBI has also expressed concern over the sharp rise in unsecured loans, prompting banks to be more cautious about their loan portfolios. The central bank has urged lenders to maintain prudent loan-deposit ratios and ensure they are not overly exposed to liquidity risks. This has led to a more measured approach to lending in certain retail segments, with some banks adopting tighter credit standards and reducing the pace of loan growth in an effort to maintain a healthy balance sheet.

Market Split on Future Rate Cuts

Adding to the complexity of the situation is the ongoing debate over the direction of interest rates. Markets are divided on whether the RBI will opt for a rate cut in December, given the recent acceleration in inflation, which rose at a faster pace than expected last month. While some analysts believe that the central bank may hold off on cutting rates until inflation is more firmly under control, others argue that a rate cut could provide relief to banks by lowering borrowing costs and easing the pressure on credit costs.

However, even if rate cuts are implemented, banks may still face challenges in repricing deposits to align with lower rates. The lag in repricing deposits could lead to continued pressure on margins, as banks would still be carrying higher-cost deposits while lending rates decline.

Conclusion

While the quarter-end deposit surge has helped banks temporarily contain the rise in credit-deposit ratios, the underlying issue of slower deposit growth relative to credit expansion remains a significant challenge for the Indian banking sector. Banks will need to continue balancing the need for liquidity with the demands of a growing loan book, all while navigating a complex interest rate environment. The coming months will be critical for the sector as it seeks to manage these competing priorities and maintain financial stability.