A person on line displays notes inside a bag for a photograph as people wait to deposit cash at a bank. (Photographer: Carlos Becerra/Bloomberg)

Why Is India’s Deposit Growth Weak? RBI Has An Answer

A slowdown in growth in deposits across Indian lenders amid rising demand for credit has raised concerns about a liquidity gap in the nation’s financial system and prevented banks from cutting interest rates.

But the question often asked is why deposit growth is weak.

A study by the Reserve Bank of India, published in its monthly bulletin, lists out the key determinants for deposit growth starting with income and returns on other competing savings and investment products.

Bank deposits are an integral part of financial savings of Indian households and the backbone to bank lending. Growth in deposits fell to its lowest in 53 years to 3 percent in November 2017, the central bank said in its report titled Bank Deposits: Underlying Dynamics. It, however, started picking up early last year. As of March 2019, deposit growth at 10 percent was marginally higher than its 15-year trend, the report said.

Why Is India’s Deposit Growth Weak? RBI Has An Answer

Also read: Banks Need Rs 25 Lakh Crore In Deposits Over Next Two Years To Meet Credit Demand

Here are factors that may have led to a fall in deposit growth, as per RBI’s study

Income Levels

Bank deposits are typically considered as a function of interest rate and income. The closest co-movement was observed between deposit growth and nominal gross domestic product growth, the study said. Deposit growth was strong in the 2003-2008 period, when nominal growth in the economy was high and slowed thereafter. The co-movement of deposit growth with the growth of nominal GDP, the report said, is stronger than the correlation with interest rates on deposits, suggesting that income effects are more powerful than price effects in driving deposit growth.

Thus, income is the most important determinant of deposit mobilisation both in the short and long-run, it said.

Besides, financial inclusion boosts deposit mobilisation over long run, the report said, making a case for expansion of bank branches in unbanked areas.

Small Savings Deposits

Mobilisation of deposits seems to be affected by substitution effects emanating from small savings in the short run, the report said. Incentives such as income tax treatment for schemes resulted in people preferring small savings over bank deposits. The RBI’s study also showed that substitution effects stemming from small savings were more frequent than correlation with other financial market instruments such as investment in equity linked instruments.

The substitution effect between small savings and bank deposits prevents banks from cutting deposit rates below the returns offered by small savings.

Stock Markets More Attractive

The growing popularity of mutual funds and other stock market instruments may also be responsible for the deceleration in deposit growth, according to the report. Traditional preference for physical assets such as real estate and gold, too, have declined. A diversion of financial savings from deposits to stock market assets is indicated by opposing movements in Sensex returns and deposit growth in the short run, the report said.

Also read: Private Banks Stretch Deposit Base To Meet Rising Credit Demand