Root of C-D mismatch: Major banks aren't competing for savings deposits

Scheduled commercial banks (SCBs) are under increasing pressure to mobilise large deposits because the incremental credit-deposit (C-D) ratio has reached 98 per cent. The ratio is usually less than 80 per cent, as banks are required to maintain a cash reserve ratio of 4.5 per cent and a statutory liquidity ratio (SLR) of 18 per cent on their deposits. Banks usually hold excess SLR securities, allowing them to sustain the incremental C-D ratio above 77.5 per cent as long as these excess securities are available.

Before the current tightening in monetary policy began in May 2022, credit growth of SCBs was 11.2 per cent year-on-year as of April 22, 2022, deposit growth was 9.8 per cent, and the incremental C-D ratio 80 per cent. By February 8, 2023, the Reserve Bank of India (RBI) had raised the policy repo rate by 250 basis points (bps). However, there was little evidence of monetary transmission, as credit growth accelerated to 15.4 per cent by end-May 2023, whereas deposit growth picked up marginally to 11.8 per cent. Consequently, the incremental C-D ratio surged to 94 per cent. The situation worsened further by August 9, 2024, when the incremental C-D ratio rose further to 98 per cent, driven by robust credit growth (15 per cent), even as deposit growth moderated (11.3 per cent).

The rise of almost 20 percentage points in the incremental C-D ratio even more than two years after the RBI began monetary tightening is counter-intuitive. In this context, it is significant that interest rates by SCBs were raised by 1-1.9 per cent on term deposits of different maturities during the current monetary tightening cycle. However, interest rates on savings bank deposits by major banks were left untouched at 2.7-3 per cent, which needs to be put in perspective.

The savings bank deposit interest rate was the last one to be deregulated by the RBI after all other interest rates were deregulated. When the RBI was to deregulate the savings-deposit interest rate, private sector banks, especially one prominent private sector bank, vehemently opposed the deregulation on the grounds that it would lead to a rate war among banks. In response to this concern, a discussion paper was issued in April 2011. After weighing the pros and cons based on the feedback received, the RBI decided to deregulate the savings-deposit interest rate in November 2011.

One of the key reasons for deregulating the savings-deposit interest rate was to improve monetary transmission. However, contrary to this, savings-deposit interest rates, even after deregulation, have remained generally unchanged and stayed at a low level. At the time of deregulation, the savings-deposit interest rate was 3.5 per cent. Immediately following this, the rates for savings-deposits at five major banks increased to 4 per cent, but they remained unchanged for the next six years till 2016-17. Savings-deposit interest rates moderated to 3-4 per cent during 2017-20 and further to 2.7-3 per cent in 2020-21, staying unchanged since then. Thus, major public and private sector banks (foreign banks do not depend much on savings bank deposits) have kept savings-deposit interest rates unchanged for several years at a stretch, other than on three occasions, unmindful of the monetary policy cycles and other interest rates in the system. This raises two critical issues.

First, major banks have been unfair to their savings-deposit holders vis-à-vis term-deposit holders. They have apparently resorted to this strategy to sustain/improve their net interest margins (NIMs). Savings deposits account for around one-third of their total deposits. The NIMs of public sector banks declined from 2.8 per cent in 2011-12 to 2.1 per cent in 2017-18, largely due to an increase in non-performing assets (NPAs) in the 2010s, but gradually rose to 2.7 per cent by 2022-23. On the other hand, NIMs of private sector banks rose from 3.1 per cent in 2011-12 to 3.9 per cent in 2022-23, with some private sector banks recording NIMs as high as 6 per cent. NIMs, which essentially represent the cost of financial intermediation, are normally considered efficient between 2 and 3 per cent.

Second, unchanged savings-deposit interest rates impaired monetary transmission. The weighted average domestic term-deposit interest rate on fresh deposits, as reported by the RBI, increased by 244 bps, and on outstanding deposits by 190 bps (between May 2022 and May 2024). However, when adjusted for savings deposit, transmission to deposit interest rates is much lower than suggested by the RBI data. This, in turn, is reflected in lower transmission to the weighted average lending rates on fresh rupee loans (by 188 bps) and on outstanding rupee loans (by 111 bps).

It could be argued that banks are more concerned with their overall deposits and their cost rather than the costs of different components. They, therefore, adjusted their term-deposit interest rates in a manner that did not require any change in their savings-deposit interest rates. If this is the case, it may not have impaired monetary transmission, but then it raises an even bigger concern of fairness to one set of depositors vis-à-vis the other.

On the other hand, if the increase in term-deposit rates by major banks was independent of any consideration of a change in their savings-deposit rates, then it did impair monetary transmission. The fact that credit growth has outpaced deposit growth significantly, despite monetary tightening, suggests that banks markedly under-priced their savings bank deposits, resulting in a sharp decline of their share in overall deposits (from 35.1 per cent in March 2022 to 31.1 per cent in March 2024). Had major banks transmitted the policy rates adequately, even if not fully, to their deposit and lending rates, the RBI possibly would not have needed to tighten monetary policy to the extent it did and it also would not have resulted in a large mismatch in the credit and deposit growth rates. 

Banks do compete for term deposits. A question that needs to be asked is why major banks do not compete for savings bank deposits. Are major banks in cahoots for not changing their savings-deposit interest rates, irrespective of the monetary policy cycles of the RBI?

The writer is senior fellow, Centre for Social and Economic Progress, New Delhi, and a former executive director of RBI