India’s banking sector is facing a growing challenge in the last few months. While bank credit continues to grow at a robust pace, deposit growth has lagged. The widening gap between credit and deposit growth is creating an asset-liability mismatch, as banks struggle to meet increasing credit demand with slower deposit inflows.
According to RBI data for the quarter ending June 2024, bank deposits grew at a rate of 11.7%, while bank credit expanded at 15%. This gap has resulted in a credit-deposit ratio (CDR) imbalance for many banks, putting pressure on their liquidity and prompting them to seek alternative funding sources. This mismatch can lead to liquidity challenges, as the slower growth in deposits limits the resources banks can use to fund loans, ultimately risking their ability to meet credit demand.
READ I Toxic work culture will extract heavy human cost
The credit-deposit gap
The issue has been aggravated by a trend of diminishing Current Account Savings Account (CASA) deposits. CASA deposits — typically low-cost funds for banks — have declined in share as more depositors are attracted to higher-interest term deposits. For instance, a FICCI-IBA report revealed that more than two thirds of respondent banks saw a decrease in CASA deposits during the first half of 2024, reflecting a shift towards term deposits as banks offer higher interest rates to attract depositors.
With deposit growth failing to keep up with credit demand, banks have turned to certificates of deposit (CDs) to raise funds. Data shows that banks issued Rs 1.35 trillion worth of CDs in September 2024, marking a 65% increase from August. This makes it the second-highest monthly issuance in the current financial year, following the Rs 1.45 trillion raised in June. Overall, banks issued Rs 7.78 trillion in CDs by August 2024, a significant 59% growth compared to the same period in 2023.
India Deposit Growth Rate (1998-2024)
This growing reliance on CDs, however, is a short-term solution. While it helps banks mobilise funds quickly — often within a day or two — CDs are typically issued with short tenors, especially in the three-month segment, accounting for 72% of total issuances. This approach, while efficient for immediate liquidity needs, creates challenges when it comes to long-term asset funding, as banks must continually roll over or replace these short-term instruments.
Regulatory pressure and future risks
In response to the growing credit-deposit gap, the RBI has increased its scrutiny of banks’ liquidity management. In particular, the central bank has raised concerns about banks relying too heavily on short-term instruments, like CDs, and has advised banks to reduce their credit-deposit ratios. The RBI is also expected to issue new guidelines on the liquidity coverage ratio (LCR), which would require banks to hold more high-quality liquid assets such as statutory liquidity ratio (SLR) investments. Funding for these SLR holdings will likely come from a mix of borrowings and deposits, increasing competition among banks to attract depositors.
As a result, banks are expected to continue offering higher interest rates on deposits, particularly on term deposits, to ensure a stable funding base. Many banks have already increased rates, with over two-thirds of term deposits earning 7% or more. However, this also raises the cost of funds for banks, potentially squeezing their profit margins.
Long-term credit demand and economic implications
The credit-deposit gap has also been fuelled by strong credit demand in key sectors. Long-term credit growth has been particularly robust in infrastructure, metals, iron, and steel sectors, driven by the government’s increased capital expenditure on infrastructure projects. According to the FICCI-IBA survey, 77% of respondents reported increased credit flow to infrastructure, reflecting the growing need for financing in this capital-intensive sector.
While this demand for credit is a positive sign of economic activity, especially in infrastructure and industrial growth, it places additional pressure on banks to find sustainable funding sources. The situation is further complicated by the fact that microfinance institutions are facing challenges with rising non-performing assets (NPAs), which could lead to further liquidity constraints in the broader financial system.
Recent data suggests that the gap between credit and deposit growth is beginning to narrow. As of early September 2024, the difference had shrunk to just over 200 basis points, down from more than 700 basis points at the start of the year. This improvement is partly attributed to the increased deposit rates being offered by banks and the rising demand for term deposits. However, the reliance on short-term instruments like CDs continues, and the RBI has cautioned banks to be wary of over-dependence on such non-retail deposits.
Looking ahead, banks will need to balance their credit growth ambitions with prudent deposit mobilisation strategies. As the RBI’s liquidity coverage requirements come into force in April 2025, banks will face further pressure to secure stable, long-term funding sources. The outlook for inflation, interest rates, and economic growth will also play a critical role in shaping the deposit growth trajectory.
The slow deposit growth in India’s banking sector is a significant concern as it leads to liquidity challenges and asset-liability mismatches. While banks have turned to short-term instruments like CDs to meet immediate funding needs, this approach is not sustainable in the long term. The upcoming regulatory changes, particularly around liquidity coverage, will add further pressure on banks to attract more deposits. For now, the sector must carefully manage its credit growth, liquidity, and deposit mobilisation to avoid future instability and ensure the continued support of India’s economic growth.