Why Kamath’s hypothesis on bank deposits is bang on

In fact, veteran banker KV Kamath provided the healing balm at Mint’s Annual Banking Conclave on January 12. He argued that bank deposits are intrinsically safe and will grow by double-digits which should be enough to meet credit demand. He does have a point. It might therefore be opportune to peel open some of the layers in the commercial banking system’s credit-deposit dynamic.

But first some basic data.

Latest data from Reserve Bank of India (RBI), which is available till 30 December, shows 14.9% year-on-year growth in total credit with deposit growth trailing at 9.2%, just a shade below Kamath’s forecast of double-digit growth. The uneven growth between credit and deposit can be gauged from how the indicator, credit-deposit ratio, has moved over the past year: it was 75.02 on December 30, compared with 71.94 same time a year ago. Movement in this key ratio also shows that the growth in the numerator (credit) has raced ahead of the growth in the denominator (deposits) over the past 12 months.

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There are a number of valid reasons for the slow growth in deposits, one of them being the long tail of the pandemic. The covid pandemic was preceded by the RBI’s concerted move since 2018 to drive interest rates low; the outbreak of the pandemic forced the central bank to not only drive rates lower but also keep the system awash in surplus liquidity. Consequently, the returns on bank deposits, after adjusting for inflation and taxes, turned negative. This became a problem for many middle-class families, especially those comprising the retired, which relied on the monthly interest rate earnings.

Around the same time, almost by coincidence, the stock market indices perked up. The shock of the pandemic and the coordinated global lockdowns initially shocked the markets, sending indices plummeting. But once markets were convinced that Armageddon had been averted, that the end of the world had been postponed, markets rallied back sharply. This diverted surplus household cash flows from banks to the markets, some directly and some indirectly through mutual funds and other financial institutions.

But as broken supply chains juxtaposed with soaring demand inflated price levels, compounded further by the Russian army marching into Ukraine in February 2022, central banks across the world started raising interest rates. At home, even the RBI raised rates by 225 basis points in five tranches. Commercial banks also had to re-adjust their loan and deposit rates. However, the art of banking requires that banks cut deposit rates faster than they raise them; it is the converse in credit where banks are slower to cut rates but have to raise lending rates faster.

It is therefore a matter of time before interest rates settle down at a rate at which returns could turn positive, even if they are marginal. And this is where Kamath’s hypothesis kicks in. He said at the Banking Conclave that banks would experience double-digit deposit growth – 10-15% growth, depending on the bank – due to the overall banking growth in the country, based on estimated gross domestic product growth for FY24. He also felt that the deposits growth would be driven by intrinsic consumer trust in the banking system, buttressed by a strong and reliable regulator (read the RBI).

The intervening three years since January 2020 have seen their share of frauds and fly-by-night operators, especially from nefarious crypto exchanges and bent fintech providers. The RBI has been constantly warning customers about the pitfalls of engaging in alternative financial products, especially those without any regulatory backstops, and has demonstrated its resolve by taking prompt action against errant bankers and other delinquent financial sector intermediaries.

So far, so good. What could spoil the party, though, is the retail sector’s new-found appetite for loans. Over the past two years, commercial banks have seen credit grow due to demand from retail consumers and non-banking finance companies (which also then on-lent the same money to retail borrowers). A good chunk of this money is suspected to have been invested in speculative avenues (such as stock markets and property) and a rising interest rate regime would require banks to demand additional equity or margin from these borrowers. This is typically when it all breaks down; the RBI has also been warning about this eventuality in its latest annual and half-yearly publications. Credit growth or deposit growth worries will then take a back seat to a completely new set of concerns.

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