Share of low-cost deposits falls as FD rates rise, banks' NIM may take hit

With RBI on monetary tightening path, liquidity has shrunk and interest rates have hardened, forcing banks to hike rates on term deposits in order to get funds for credit growth

With interest rates on term deposits rising, the accretion of low-cost deposits – CASA (current account and savings account) – is seeing moderation at banks. This may, in turn, impact their margins, going ahead.

Most banks that have announced their July-September earnings, with either flat growth or a dip in their CASA ratio during the quarter. The country’s largest lender State Bank of India (SBI) saw its CASA ratio decline to 44.63 per cent in Q2FY23 from 46.24 per cent in the year-ago period. Similarly, the ratio at HDFC Bank, the country’s largest private sector lender fell to 45.4 per cent in Q2 from 46.8 per cent a year ago.

With the Reserve Bank of India (RBI) on a monetary tightening path, liquidity in the system has shrunk and interest rates have hardened, forcing banks to increase rates on term deposits in order to get funds to support credit growth, which is at multi-year high.

Experts believe there could be some movement of funds from low-cost deposits to higher yielding deposits now that interest rates on FDs are picking up after a long lull. Most major banks are now becoming aggressive in garnering deposits and are offering attractive interest rates on term deposits to customers. Interest rates on fixed deposits on select tenors are touching as high as 7.5 per cent for some banks for deposits below Rs 2 crore.

The flight of funds away from CASA to term deposits is expected to put pressure on margins of some lenders that depend on high interest rates to garner deposits. Banks have posted higher margins in Q2 as the transmission of rate hikes on assets and liabilities have not been uniform. While loan rates have gone up substantially, the uptick in deposit rates has been quite slow.

“The CASA ratio is a function of both the numerator and the denominator. CASA remaining the same, if there is a flight of deposits, the ratio looks inflated and the reverse is true. Post Covid, consumerism is reaching new highs, notwithstanding the inflationary pressures. Secondly, people are preferring to park their funds in high yielding avenues, commonly referred to as dis-intermediation”, said AK Das, MD & CEO, Bank of India.

According to Das, interest elasticity should not have a bearing on the CASA ratio because customers now have the option of auto switch, wherein if there is excess money in customers’ savings account, it gets transferred to the FD accounts, fetching them higher returns.

“When the economy is expanding, the money multiplier increases. This is why deposits are growing at a much slower pace than advances. Banks are realigning their liability pricing and coming out with special deposit schemes. These initiatives will definitely have a bearing on the margins but will keep the liabilities in place to fund credit growth”, Das said.

Nitin Aggarwal, Sr. Group VP, Motilal Oswal Financial Services Ltd, said, “The CASA ratio is already moderating across banks. We have witnessed this trend in the Q2 results of major banks. This trend is likely to continue as interest rates on term deposits go up further. As the banks look to mobilise more deposits, we can expect further moderation in CASA ratio.  

“As term deposit rates are rising, there could be some movement of deposits from savings account (SA) to term deposits because customers may prefer to lock in interest rates at higher levels, given the muted rates offered by the banks in the last two years, resulting in a moderation of SA balances growth. This could be challenging for banks where the difference between the SA and TD rates narrows. Banks whose deposits are driven by the interest rate proposition may face a bigger challenge due to this. So, such banks could face margin pressure as the CASA accretion slows down”, said Anil Gupta, Vice President – Financial Sector Ratings – ICRA.

On the impact on margins, Aggarwal said, it will be a factor of how the banks are positioned on the lending side. “In the near term, my sense is that repo rate hike and its transmission to lending rates, will continue to drive the yields. Therefore, the margins could do well in Q3 and Q4. Thereafter when the cost of funds inches up, there could be some margin compression. And this will play out from Q2FY2”, he said.

Credit growth in the system has picked up substantially in the past few months, albeit on a low base, mainly driven by the retail and the MSME segment. However, deposit growth has been trailing credit growth by a substantial margin, leading to concerns that deposit growth may become one of the constraints for future uptick in credit growth. As per the latest RBI data, bank credit has grown 17.9 per cent year-on-year (YoY), a 10-year high, for the fortnight ended October 21. During the same period, deposit growth has grown 9.5 YoY, resulting in a credit – deposit growth gap of 840 basis points.