THE CONTEXT: The banking sector is grappling with a significant deposit crunch as the gap between bank deposits and credit growth widens, posing risks to profitability and economic stability. This situation is exacerbated by rising competition, technological advances, and changing saver behaviors, necessitating strategic interventions.
THE ISSUES:
- Impact on Loan Growth: There is a concern about whether declining deposits will constrain banks’ ability to support loan growth. The relationship between deposit growth and loan growth is complex, as banks may seek new deposits due to strong loan demand or vice versa. Empirical evidence suggests both scenarios are true, and a decline in deposits can significantly impact loan growth, particularly for small banks.
- Widespread Decline in Deposit Growth: The decline in deposit growth affects all banks, including major public and private sector banks, as indicated by their management commentaries and financial results. This widespread decline raises concerns about the banks’ ability to support credit growth.
- Greater Impact on Smaller Intermediaries: Smaller banks and financial institutions rely more on core deposits and have fewer funding alternatives. As a result, they are more vulnerable to deposit declines, which can reduce their capacity to extend loans, particularly to small businesses.
- Constraints on Last-Mile Lending: The deposit crunch could impact the flow of credit through Non-Banking Financial Companies (NBFCs), microfinance institutions, and other smaller players that depend on banks for funding. This could hurt consumption and investment activities, particularly in rural and underserved areas.
- Differential Impact on Loan Portfolios: Slower deposit growth does not affect all loan portfolios equally. While retail demand remains robust, the industrial sector has not yet shown significant demand beyond working capital needs. However, if industrial demand increases, the deposit crunch could limit banks’ ability to meet this demand, potentially affecting economic activity.
- Need for Competitive Alternatives and Policy Measures: Banks must offer more competitive products to attract savers and manage costs effectively. Policymakers are encouraged to deepen bond markets to provide alternative funding sources for banks. This is crucial as banks face challenges in generating income and managing costs amid declining deposit growth.
THE WAY FORWARD:
- Focus on Small Deposits: Banks should mobilize small deposits rather than rely solely on large deposits. This approach can help stabilize the deposit base and reduce reliance on volatile funding sources. In 2014, the Pradhan Mantri Jan Dhan Yojana (PMJDY) was launched in India to increase financial inclusion, opening millions of new small deposit accounts.
- Innovative Financial Products: Banks must offer competitive and innovative financial products to attract savers with alternative investment options such as stock markets. This could include higher interest rates on savings accounts or new investment products that offer better returns. ICICI Bank introduced innovative savings products like the “iWish” flexible recurring deposit, which allows customers to set savings goals and deposit any amount at any time.
- Re-strategizing Business Plans: The RBI Governor has urged banks to rethink their business strategies to maintain a prudent balance between assets and liabilities. This includes ensuring that credit growth does not outpace deposit growth, which can lead to liquidity issues.
- Monetary Policy Adjustments: The RBI can play a crucial role by adjusting monetary policies to ensure the gap between credit and deposit growth does not widen. This includes monitoring the credit-deposit (C-D) ratio and implementing measures to address imbalances.
- Tax Incentives: The government could consider tax breaks on interest from bank deposits to make them more attractive to savers and boost deposit growth.
- Deepening Bond Markets: Policymakers are encouraged to focus on deepening bond markets, which can provide banks with alternative funding sources and reduce reliance on deposits. This structural change can help stabilize the financial system in the long run. The development of the corporate bond market in South Korea has provided banks with alternative funding sources, reducing their reliance on traditional deposits and stabilizing the financial system.
- Technological Advancements: Banks should leverage technological advancements to streamline operations and reduce costs, making them more competitive in attracting deposits and managing credit growth effectively. SBI’s YONO platform has streamlined banking operations and reduced costs, making banks more competitive in attracting deposits.
THE CONCLUSION:
Addressing the deposit crunch requires a multifaceted approach, including innovative deposit strategies, regulatory adjustments, and structural reforms. Banks can stabilize their funding base by implementing these solutions and supporting sustainable economic growth.
UPSC PAST YEAR QUESTIONS:
Q.1 The savings rate is the most effective among several factors for India’s potential growth. Do you agree? What are the other factors available for growth potential? 2017
Q.2 Pradhan Mantri Jan-Dhan Yojana (PMJDY) is necessary to bring the unbanked to the institutional finance fold. Do you agree with this for the financial inclusion of the poorer section of Indian society? Give arguments to justify your opinion. 2016
MAINS PRACTICE QUESTION:
Q.1 Discuss the implications of the persistent gap between credit growth and deposit growth in the banking sector. How does this trend affect financial stability?
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