Why Deposit Growth is at a Twenty-Five Year Low


The Reserve Bank of India releases the aggregate deposits with scheduled commercial bank data every week.

Data released on April 22, 2016, suggests that for the year 2015-2016, the aggregate deposits with scheduled commercial banks grew by 9.72%. This is the lowest in more than 25 years and the second lowest in more than 50 years.

Only in 1990-1991, the year before economic reforms were introduced, had the growth been slower at 9.65%. Also, this is the second lowest deposit growth since 1963-1964. Further, it is only the second time that deposit growth has been in single digits since 1963-1964.

And this is a worrying trend.

Why is this happening? One reason is that household savings as a whole have fallen over the years primarily because of the high rate of inflation that prevailed between 2008 and 2013. The household savings fell from 22.2% of gross national disposable income in 2011-2012 to 17.8% in 2013-2014. More recent data points are not available.

The household financial savings was at 7.5% of gross national disposable income in 2014-2015. As the RBI annual report for 2014-2015 points out: “Growth in aggregate deposits, which forms a major component of money supply, has generally been declining over the years in line with a decrease in the saving rate of the economy. In addition, slowdown in credit growth led to lower deposit mobilisation by banks.”

Raghuram Rajan, the governor of the Reserve Bank of India (RBI), has also offered another reason, whenever this question has been put to him. When deposit growth was faster inflation was also higher, he has explained. In 2010-2011, the aggregate deposits with scheduled commercial banks grew by 15.3%. The consumer price inflation during the year was at 10.45%. In 2012-2013, the deposits grew by 13.8% and the inflation was at 10.44%.

In 2015-2016, the consumer price inflation was 4.83% and the deposit growth was at 9.72%. Once we look the growth from this angle, suddenly it doesn’t look as bad.

In fact, there is another important reason for the fall in the aggregate deposits growth and this reason is not so obvious.

The loan growth of banks (i.e. non-food credit) has been slow over the last few years and this has led to slower deposit growth as well.

In 2015-2016, the total amount of loans given by scheduled commercial banks grew by 10.3%. This was better than the 9.3% growth seen in 2014-2015, but low nonetheless. In fact, the loan growth in the last two years has been the slowest since 1993-1994.

This has had an impact on deposit growth. And how is that? As Michael McLeay, Amar Radia and Ryland Thomas of the Bank of England write in a note titled Money Creation in the Modern Economy: “The vast majority of money held by the public takes the form of bank deposits. But where the stock of bank deposits comes from is often misunderstood. One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them. In this view deposits are typically ‘created’ by the saving decisions of households, and banks then ‘lend out’ those existing deposits to borrowers, for example to companies looking to finance investment or individuals wanting to purchase houses.”

As it turns out, things are not as straightforward as that. As the Bank of England authors write: “Commercial banks create money, in the form of bank deposits, by making new loans.”

How is that possible? Let’s say an individual deposits money in a bank. The bank uses that money to make a car loan (assuming that the deposit is large enough). The money is deposited into the account of the borrower. The borrower of the car loan uses that money to buy a car and pays the car dealer. The money is deposited in the account of the car dealer. The car dealer in turn uses that money to pay his employees.

The employees when they are paid, money is deposited into their savings bank accounts. Hence, a loan creates more deposits. The employees then withdraw a part of that money to meet their monthly expenditure. They may also transfer a part of their deposit from a savings bank account into a fixed deposit.

A part of the money that the employees withdraw goes towards paying their local kirana wallah(or the mom and pop shop) from where their monthly grocery is bought. A part of this spend again finds its way back into the bank as a deposit.

This multiplier effect essentially ensures that new loans create more deposits. And given that loan growth of banks has been slow, it is not surprising that deposit growth is slow as well. Hence, for deposit growth to pick up loan growth will have to pick up.

And what needs to happen for loan growth to pick up? The simplistic answer is that lower interest rates will lead to higher loan growth. But things are not as simple as that. Interest rates also need to be maintained over the prevailing rate of inflation in order to encourage people to save. Further, lower interest rates do not always encourage people to borrow, as is more than obvious across large parts of the Western world, currently.

What needs to improve is the promoter interest in doing new business for which they need to borrow.

As Mahesh Vyas of Centre for Monitoring Indian Economy wrote in a recent piece: “Why do a significantly large number of projects continue to be stalled when most important reasons for phenomenon have already played themselves out? The most prominent reason turns out to be lack of promoter interest. One third of the total investments whose implementation was stalled in 2015-16 was because of lack of promoter interest. Another 15 per cent of the promoters who stalled implementation stated that the current market conditions were unfavourable to pursue their projects further. The two reasons are essentially the same – that these are not very good times to invest.”

The column originally appeared on The 5 Minute Wrapup on April 29, 2016

Deposit Growth at a 53-Year Low: Are Banks in a Position to Cut Interest Rates?


The Reserve Bank of India’s first monetary policy statement for the financial year 2016-2017 is scheduled to be released on April 5, 2016. Given this, it is not surprising that demands for a cut in the repo rate are being made. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark for the short and medium term interest rates in the economy.

Economists and analysts expect the Reserve Bank of India(RBI) will to cut the repo rate by 25 to 50 basis points. With this cut, it is hoped that banks will cut their lending rates as well. As banks cut the interest rates on their loans, people will borrow and spend more. As people borrow and spend more, by buying more cars, more homes, more consumer durables and more two-wheelers, companies will benefit.

This will help economic growth. Low interest rates will also help companies which have huge debts to service. In short, this is Economics 101.

The trouble is that this Economics 101 works with the assumption that if the RBI cuts the repo rate, banks will cut their lending rates as well at the same pace. The question is will this happen? The past experience shows that the direct correlation between RBI cutting the repo rate and banks passing on that cut at the same rate in the form of lower lending rates, is rather weak.

As Crisil Research had pointed out in a report released in February 2015: “Lending rates show upward flexibility during monetary tightening but downward rigidity during easing. Between 2002 and 2004, while the policy rate declined by 200 basis points, lending rates dropped by just 90-100 basis points. Conversely, in 2011-12, when the policy rate rose by 170 basis points, lending rates surged 150 basis points.

The RBI governor Raghuram Rajan had made a similar point in December 2015 when he had said: Since the rate reduction cycle that commenced in January [2015], less than half of the cumulative policy repo rate reduction of 125 basis points has been transmitted by banks. The median base lending rate has declined only by 60 basis points.”

The point being that when the repo rate goes up, the banks are fast to pass on the hike to the end consumers, in the form of higher lending rates. But the vice versa does not seem to be true. Why is that? A simple answer is greed or the need to make more money. Further, the trouble this time around is that public sector banks are staring at a huge amount of corporate bad loans.

In order to handle this, banks are hoping to make a greater profit by cutting their deposit rates, but not cutting their lending rates at the same rate. Nevertheless, this is just a part of the problem.

Latest data released by the RBI shows that deposit growth has slowed down tremendously. Deposit growth in 2015-2016 (actually between March 20, 2015 and March 18, 2016) came in at 9.9%. The Mint newspaper reports that this is the lowest since 1962-1963. Back then, the growth in deposits had stood at 6.5%.

I couldn’t independently verify this. Nevertheless, RBI’s Handbook of Indian Statistics has data for deposits with scheduled commercial banks from 1976-1977. This data clearly shows that the deposit growth in 2015-2016 has been the slowest in all these years. At 9.9% it is even slower than the deposit growth in 2014-2015, which was at 10.7%.

The deposit growth during 2011-2012, 2012-2013 and 2013-2014 had stood at 11.75%, 14% and 14.29% respectively.

So what does this mean? Banks make loans from deposits which they are able to raise. And if the deposit growth is almost at an all-time low, their ability to cut interest rates on their loans, will be limited. If banks cut deposit rates any further, the deposit growth will fall further and this will hurt their ability to give out loans.

There is another data point that needs to be looked at here—the incremental credit deposit ratio. This ratio is obtained by dividing the total loans given out by banks in the last one year by the total deposits raised by banks during the same period.

The incremental credit deposit ratio as on March 4, 2016, (the credit data as on March 18, 2016, is still not available), stood at 83.5%. This means that for every Rs 100 raised by banks as deposits, they lent out Rs 83.5.

It needs to be mentioned here that for every Rs 100 banks raise as deposits, they need to maintain Rs 4 with the RBI as a cash reserve ratio(CRR). Further, they need to invest Rs 21.5 into government bonds in order to maintain the statutory liquidity ratio(SLR). This leaves banks with Rs 74.5 to lend out of every Rs 100 that they raise as deposits.

The fact is that they have lent Rs 83.5 during the last one year. This has been possible because of the fact that the incremental credit deposit ratio between March 2014 and March 2015 had been at 68.7%. The low number gave banks scope to lend more in 2015-2016.

The point is that if the loan growth does pick up a little more from here, the incremental credit deposit ratio is likely to get worse in the days to come. If we take this possibility into account, banks will have a tough time cutting down their deposit rates any further. And that being the case, the chances of lending rates being cut further are limited.

But this is something that those demanding interest rate cuts all the time, are not in a position to understand.

The column originally appeared in Vivek Kaul’s Diary on April 1, 2016