The relentless alerts from Reserve Bank of India about structural issues facing the banking system and the deposit crunch begs a deeper inquest.
The latest data showing base money supply of the RBI slowing to near multi-decade low of 3.8% foretells continued drag on both the broad money and bank deposits, which at 10.8% and 10% are lagging the credit growth averaging at 15%. Consequently, the credit-deposit ratio banks has risen to a peak of 77-78%. The scamper of deposits has forced banks towards asset-liability mismatch to sustain lending.
RBI attributes this problem to households shifting away from bank deposits towards stocks and mutual funds.
But in essence, the banking sector drag is rooted to the macroeconomic disequilibrium caused by past shocks and the lopsided post-COVID recovery, which has impacted households in a structural manner.
Compared to 15 years ago, household income and real wages have decelerated substantially. At 3.9% compound annual growth rate
(FY19-24, RBI KLEMS), growth in real worker wages has declined by 5.8 percentage points (pp), more than nominal (9.3%) and real (4.4%) GDP growth which have decelerated by 5.2pp and 3.6pp respectively. The disequilibrium also feathers weak private capex despite corporates gaining from the policy impetus, stepped up government infra capex and post-COVID bounties.
Since the dominant share of household in the overall GDP has come down, the overall money demand has slowed. The correlation of bank deposit growth with household income has increased significantly since FY11 to 0.91. Consequently, the growth in broad money (M3, 10% CAGR) and deposits (10.5%) have seen a larger deceleration of 9pp and 10.5pp respectively.
Banks have also seen a structural slowdown. With broad money slowing to an average of 10.5% since FY11, bank deposit and credit growth averaged at 10.8% and 11.4% respectively; 11.7% and 15.1% respectively for Jul’24.
These are significantly lower than averages during FY85-FY11; broad money at 17.2%, and even higher deposit and credit growth at 17.8% and 18.5% respectively.
The structural dampeners for deposit are multi-faceted:
a) the share of households in bank deposits has declined from the recent peak of 63% in FY18 to 61% in FY24,
b) improved corporate cashflows resulted in their contribution rising from 10.8% to 14.3%,
c) governments deposits have slowed fallen from 14.6% to 12.5%, and,
d) despite the robust 18.2% 5yr CAGR growth in private corporate deposits, the metropolitan areas which dominate the overall deposit accretion have seen a modest growth in deposits. This implies that the household deposits even in metropolitan areas have been subdued, akin to the situation in rural, semi-urban and urban areas.
Constrained household income has also resulted in a skewed lending profile with disproportionate reliance on retail lending backfilling for shortfall in income even as corporates lack demand for capex led credit.
Consequent to the disequilibrium, banks are forced banks to rely on non-deposit liabilities to fund retail lending. It rose to 9.5% of total liabilities from 5.8% pre-COVID level (currently at 8.4%). And since this imbalance is unsustainable and fraught with risks, the credit deposit ratio will need to decline by at least 300 basis points in a normalisation process, which may take two years.
Evidently, the lack of deposit growth is not due to RBI induced constraints. Over the last 8.4 years, 78% of the 200 fortnights have seen surplus balances under RBI’s Liquidity Adjustment Facility with an average of 2.2% of bank deposits. Thus, RBI’s monetary easing at the current juncture could be futile; it would further stimulate retail lending and be inconsistent with the lagging bank term deposits and the RBI’s recent attempts to bring down the credit-deposit ratio.
The adverse household situation is associated with a high level of effective unemployment, contracting labor productivity, and real wages per worker. Enabling positive real income and revival in financial savings would require the RBI to sustain inflation below its outmoded target of 4% adopted in 2016.
The peak levels of credit-deposit ratios have not resulted in better profitability. Improved corporate balance sheet and cash flows have implied lower NPAs (non-performing assets) but also low yields on assets due to lack of capex. Over-reliance on retail lending is associated with heightened competition, low margins and sustained lower core profitability even as NPA write-backs from earlier provisioning and dwarfing of retail NPA ratios due to exuberant retail lending have aided reported profits.
Compared to the third quarter of FY22, credit-deposit ratios of most large banks are currently 600-700 basis points higher with large private banks ranging at 80-100%. But they have started to fall. For public sector banks it continues to rise to 70-76%. There has been a sharper fall for smaller private banks and small finance banks. Consequently, there has been a significant rise in NPA ratios for small finance banks and micro finance institutions. Public sector banks continue to see a decline in NPA ratios, while for the large private banks, the NPA ratios are beginning to rise.
Thus, the performance of banks is susceptible to the anticipated reduction in the credit-deposit ratio. The fall in this ratio could extend the pressure on margins, reduce return ratios and increase NPAs, collectively leading to further pressure on valuations.
