By Garima Singhal & Vishnu Pillai


Reserve Bank of India’s bimonthly report in March revealed that the deposit growth in the fiscal year 2015-16 has slipped to 9.9%, the lowest in the last five decades. India is an economy, which is considered as saving centric, and the country’s banking system provides the depositor with one of the highest interest rates ranging from 4.5%-7.5% on time and demand deposits (up to Rs. 1 Crore). Inflation has seen a downward trend and the economy is moving towards faster growth. In spite of all these reasons, Indian banks are facing liquidity crunch due to low deposit growth that has also led to an increase in the credit-to-deposit ratio to 77.6% in March 2016 from 76.5% in the previous year.

In all this debate, the question arises why deposits in banks are so important for India’s growth and if the nation is really growing at a high growth rate then why are deposits in the banking system decreasing to such a large extent?


                              Figure 1: Growth in bank deposits (in %), Source: RBI


India is a developing country rapidly moving towards better technology and efficient ways of working. Similarly is the financial market of the country, which is currently in its growing phase. A financial market is a market where direct trading takes place in equity, bonds, currency, commodities etc. Here the investors and people in need of funds meet directly without the need of intermediary like banks. As the financial market of the nation grows and become more efficient, the need for banking sector becomes less important. However, in India where financial markets cope with the problem of adverse selection and moral hazard, banks play an important role in transferring funds from investors to borrowers.

Moreover, banks work on the principle of spread, which is the difference between the interest paid on deposits and interest earned on loans. As deposit growth falls and demand for the loans increases, banks need to increase the rate of interest on their deposits resulting into less spread for banks and reduction in profitability.

Also, with the current credit-to-deposit ratio of 77.6%, banks are lending 77.6 rupees for each of Rs. 100 of deposit. As banks need to maintain other reserves under CRR and SLR, lending such a high amount can lead banks to run into a liquidity shortage, which is not a favorable situation for the banking system as a whole.

As a result of all these factors, deposits have become a crucial component in the banking system to facilitate the smooth flow of funds from investors to borrowers.


                  Figure 2: Prime Lending Rate in India from April 2015 – March 2016,

                                              Source: www.tradingeconomics.com


In countries like India and China people tend to save more for the future than consuming today. As a result of this saving habit of citizens, the Indian economy was hit to a lesser extent during the Financial Crisis of 2008, but what has led to the reversal of this trend in current times? Though there is no sure answer for this question, few factors explain the reversal to some extent.

In the past when the country was facing a double-digit inflation, banks were providing high-interest rates on deposits, to reduce the impact of inflation on people’s savings. But as inflation eased, interest rates on deposits have not reduced in the same proportion providing people with a higher real rate of interest. This has resulted in people earning same returns with fewer funds parked in the banks. This could have resulted in the reduction of deposits in banks.

Moreover, the behavior of present generation is changing, as people want to fulfill more of their present demands than saving for the future. The availability of various insurance schemes in the market to face future uncertainties has made this task of present consumption more attractive, preventing people from worrying about future thereby saving less.

Second of all, as the financial market in the country is growing and becoming more efficient, new and better products like Mutual Funds, Equity Traded Funds, Bonds, Real Estates etc. are becoming available to people to earn more profit with the same amount of money invested. Also, the returns provided by these investments are far above the inflation rate resulting in more returns in nominal as well as in real terms. Another reason for the growing popularity of financial products is the liquidity they provide. As a result, people who are willing to take risks to earn higher profits are moving towards these products rather than parking their funds in banks.

Another reason that can also be considered as one of the factors for falling deposits growth is an increase in the maximum limit under the Liberalized Remittance Scheme. Under this scheme, the RBI defines the maximum permissible amount that Indians can remit to other countries. The maximum amount under this scheme has been raised to $250,000. As a result of this, people have started sending more money to their parents, children or relatives in foreign countries instead of saving them in bank accounts. This can be validated from the fact that the transactions under this scheme have seen a jump from $106mn to $449mn from May 2015 to Feb 2016.

The largest factor that is contributing to this rise is the amount sent by parents to children who are studying abroad. This shows that our education system is not only incapable of retaining its talent but also is one of the major causes of money leaking out of the economy.

The points discussed above identify the fact that people presently are reluctant to put money in banks. But what if in the previous years the funds deposited by people was just higher deposit growth than normal rate and presently that trend is only getting reversed to attain its normal pace. This can be inferred from the fact that during the period of Financial Crisis, markets were facing great uncertainty and the economy was experiencing double-digit inflation. People were losing jobs and were more focused on saving to secure their future consumption as much as possible, which led to very high growth in deposits. As the economy recovered from recession over the years and inflation rates have fallen, people have reverted to their actual rate of spending bringing the deposits growth down.

The other factor that is more perplexing is that in the situation when deposit growth is at its all-time low, currency in circulation is seeing a high growth of 14.6% as compared to 11.32% growth over the previous year.

In the scenario where not only advance ways of doing banking are coming up every day resulting in improvement in efficiency of transactions but also schemes like Pradhan Mantri Jan Dhan Yojana(PMJDY) which are trying to put ideal money into circulation by opening up bank accounts, high growth in currency in circulation despite fall in bank deposits raises questions. Though this increase can be described by few factors, actual reasons remain uncertain.

Elections could be seen as one of the reasons for the rise in currency, as it is a phase where a large amount of money is spent by political parties for funding their campaigns and to lure the voters by offering them cash. The rumor of each voter in Tamil Nadu getting somewhere between Rs.3000 to Rs.6000 during the Assembly Election in April – May 2016 added fuel to this fire. Even Mr. Raghuram Rajan hinted this as a possible reason for an increase of Rs. 50,000 crores more money in the hands of the public than what was expected by the Central bank. Another interesting fact that came to light during this period was that the amount of money with the people had not only increased in the poll-bound states but also the neighboring states.

But if we were to believe the above reasoning then didn’t we have more states going for elections last year? Why didn’t the level of deposits fall in the last year or the year before it during the elections? Or is it that the states that went to polls last year (Bihar, Delhi- 2015) or in 2014 (Parliament, Maharashtra, Haryana, Andhra Pradesh, Jammu & Kashmir, Jharkhand) had a better follow-up of electoral policy than the states that had elections this year (Kerala, Tamil Nadu, Assam and West Bengal).

Another factor which gives rise to the possibility of high currency in circulation is the rise in service tax from 12.36% to 14% and with the introduction of the Swachh Bharat cess and Krishi Kalyan cess, it reaches to 15%. Because of this rise, people may be seen as reluctant to put large sums in banks due to increase in transactions costs or ATM charges. Though the cost may be lower on transaction basis but combined cost may result in keeping people away from depositing in banks. Moreover, with the rise in service tax people may be more willing to pay for services in cash instead of through bank accounts as transactions from accounts are recorded whereas cash payments cannot be traced and can be used as a means of saving tax.

All this presents one side of the picture that concludes that people are not depositing at the same rate as of before but there is a second angle to the picture. What if people are still saving at the same rate but they do not have enough income to save which is leading to the fall in deposits growth?

The data based on Quarterly Employment Survey (QES) of  the number of jobs created in select eight industries shows that the number of jobs generated in 2015 is only 135,000 which are very low as compared to that of jobs created in 2014 that were 421,000. This fact puts another problem in picture that though the economy is growing at a rate of 7.4% currently it is facing difficulty in translating the growth into increased jobs to accommodate the growing workforce of the country. Moreover, in the rural area the fall in income due to crop failures caused by two successive droughts is aggravating the problem. This has resulted in farmers losing their crops and worsening the situation in both urban as well as rural areas.


                Table 1: Changes in employment in selected sectors (in lakh numbers)

                                                       Source: Labour Bureau

The actual reason for such a high fall in growth of deposits is still unknown. In a scenario, where the economy is booming and with the pressure from industry to reduce the interest rates is continuously growing, banks will be required to reduce the interest rate on their deposits as well so as to maintain their Net Interest Margins (NIMs). However, as banks are already facing the problem of lower deposit growth, reducing deposit interest rate may make the situation worse forcing banks to face a highly constrained situation from both low deposits as well as high loan demands. Therefore the banks will be required to come up with schemes that can give investors attractive payoffs to deposit money in the bank and to focus on making the banking system more robust so as to not only reduce the growing NPAs but also control the increasing growth of currency and inject back the money which is currently out of the system.

Post March 2016, the deposit growth has increased in banks. So this fall in deposits growth in FY2015 may be considered as one time phenomenon but if such a trend continues to persist in the future, banks should not only focus on finding the root cause of such a high decrease but also try to find new avenues to earn its income so as to bear the brunt of its reduced NIMs.


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