Why spate of bank deposit rate hikes could be a thing of the past

Around 85% of the Rs 2000 notes are deposited in the bank accounts and not exchanged for smaller denominations. Thus, bank deposits are likely to increase by atleast Rs 2 lakh crore

Ever since the Reserve Bank of India announced the withdrawal of Rs 2,000 notes on May 23, about half of those notes in circulation have already come back to the banking system, RBI governor Shaktikanta Das said on Thursday. The last day to exchange or deposit these notes with banks has been set as September 30.

State Bank of India expects the banking system deposit base to increase by Rs 1.4 trillion to Rs 2 trillion due to the deposit of Rs 2,000 notes.

"Around 85% of the Rs 2000 notes are deposited in the bank accounts and not exchanged for smaller denominations. Thus, bank deposits are likely to increase by atleast Rs 2.0 lakh crore assuming some of the notes would already be with banks in currency chests. Overall deposit growth in FY24 should grow over 11 per ccent year-on-year. This will effectively imply that spate of deposit rate hikes could be a thing of the past," said Dr. Soumya Kanti Ghosh, Group Chief Economic Adviser at State Bank of India.

The consequent increase in banking liquidity will ensure that there is no immediate need for a cash reserve ratio, (  percentage of a bank's total deposits that it needs to maintain as liquid cash) cut.

The report stated that the liquidity surplus in the system has again increased with the net liquidity adjustment facility (LAF) absorption at Rs 2.2 trillionn as on 07 June from an average of Rs 1.0 lakh crore from April to May 2023. 

As  on March 31, there were Rs 3.62 trillion worth Rs 2,000 notes in circulation. After the withdrawal announcement was made, so far about Rs 1.8 trillion worth of 2,000 notes have come back.

"Around Rs1.8 tn (out of Rs3.6 tn outstanding) of Rs2,000 bank notes have been taken out of circulation, of which Rs1.5 tn is in bank deposits. The liquidity will remain in surplus, at least over the next few months, assuming the current trend in bank note deposits continues and forex flows remain steady. Given the surplus liquidity in the system and the prospects of it staying in surplus, we see a lower probability of a CRR cut or OMO purchase, as expected earlier," said Upasna Bhardwaj, economist at Kotak Mahindra Bank. 

Similarly, Sonal Badhan, an economist at Bank of Baroda, said the return of the Rs 2000 notes in banks is expected to increase liquidity, at least on a temporary basis. "Our estimates show that depending upon the percentage of Rs 2,000 notes deposited in the bank (25%/50%/75%), liquidity may go up by Rs 0.9-2.7 trillion.

The RBI pausing its  rate hike cycle also means that banks will no longer be under pressure to raise deposit rates to attract funds. "Deposit growth has also been strong in recent months, which means that banks may have less need to raise rates to meet their funding requirements. Lastly, the government has announced measures to boost economic growth, which could lead to increased demand for loans and therefore lower deposit rates," said Adhil Shetty, CEO of BankBazaar.

Given that banks are flush with funds, and the RBI decided to keep the repo rate unchanged at 6.5 per cent on Thursday, it is time for investors to reconsider reinvesting their fixed deposits now for higher returns.

Most banks provide rates of 7% or more on select deposit tenors. Smaller banks are at 7.5% and many small finance banks are above 8%. Senior citizens are being offered a premium of 25 to 75 basis points. Some government banks are offering super senior citizens (those above 80) additional premium. 

"The pause in the repo rate hike coupled with surplus liquidity in the banking system may lead bigger banks with adequate deposit mobilization to halt their FD rate hikes. Thus, depositors can start booking FDs for longer tenures, especially if those are offered at attractive yields. However, banks having more aggressive targets for their credit growth or those having relatively smaller deposit bases may resort to further FD rate hikes to achieve their targeted credit growth," said Naveen Kukreja, Co-Founder & CEO, Paisabazaar.

"In line with market expectations, RBI did not change the policy rates in yesterday's MPC meeting. With inflation in the tolerance band and expected to remain around 5%,  the market expects RBI to start cutting rates towards the end of this financial year. Against this backdrop, it's an excellent time for retail investors to lock in fixed income rates," said Anshul Gupta, Co-founder and Chief Investment Officer, Wint Wealth.

For conservative investors, fixed deposits with small finance banks could be a great option since they provide 150-200 bps higher interest rates than larger banks and come with deposit insurance of up to Rs 5 lakh per account.

For moderate-aggressive investors, debt mutual funds and corporate bonds could be an excellent way to increase their debt allocation in their portfolios," said Gupta.