Disparity in growth rates between credit & deposits: Time for monetary policy tweaking to avert bank credit crisis

Credit support by commercial banks is a lifeline in any economy as it plays a crucial role in the economy’s development. Access to easy bank credit facilitated the promotion and success of many entrepreneurs especially, the new generation businessmen.

For financial assistance from banks, there wouldn’t have been today international brands like Infosys or OYO hotel chain promoted by persons from ordinary backgrounds. There are thousands of such cases of becoming successful businessmen despite coming from non-business family backgrounds. It doesn’t mean to say that family entrepreneurs are not dependent on the banking system. No sensible businessman uses his capital.

Recently S&P Global Ratings has expressed the apprehension that banks may be compelled to reduce credit availability shortly as a result of the failure of the banks to attract deposits in sync with demand for credit. A closer examination of the data reveals that there is a significant disparity in growth rates between credit and deposits.

The growth in bank credit between January 2022 and January 2024 was 39.88%, while the growth in deposits was comparatively lower at only 20% during the same period. The gap between the deposit and credit growth rates started widening in May 2022, ironically coinciding with the RBI’s decision to raise policy rates.

For instance, the year-on-year deposit growth rate in March 2022 was 8.94% as compared to a 9.60% credit growth rate. The position of credit disbursal growing at a faster rate than the deposit growth continued to worsen further. At the end of December 2023, credit disbursal grew at 20.1% as compared to slower growth of deposits at 14.1%. A little moderation was observed in both credit [16.2%] and deposit growths [12.4%] in mid-January 2024.

In a normal situation bank deposits grow at a higher rate than the credit growth rate. For instance, credit disbursal grew at 5.6% against the 11.4% growth of deposits in March 2021 which reflected how comfortable banks were to meet any demand for credit support by the stakeholders in the economy.

No doubt, the growing demand for credit support is a promising sign of economic growth as there is a positive correlation between the two. However, if deposits fail to keep up the phase that would be an alarming situation. Ultimately, it would mean the inability of the banking system to stand up to the market in terms of credit support to the economy. It is in this context that S&P has come out with a report fore-warning the policy makers.

The trend in credit-deposit ratio
The credit-deposit ratio is a broad indicator of how banks perform, that is, whether they are in a position to fully utilize the profit-making opportunity or not. It is important to understand that banks are entitled to utilize up to 77.5% of the net demand and time deposits they attract under the prevailing reserve ratio norms. That is, after maintaining 4.5% of the deposits as a cash reserve ratio [CRR] and investing 18% of the deposits in the form of government-approved bonds as a statutory liquidity ratio [SLR].

The credit-deposit ratio was below the 77.5% mark until March 2023 when it was at 75.8%. The credit deposit ratio was only 71.8% in March 2021. The industry was not enthusiastic about availing easy credit support despite the liberal approach by the Reserve Bank of India in the post-pandemic period. Why would anybody risk to produce under the subdued market situation?

Since the third quarter of 2023-24, the credit-deposit ratio exceeded the permissible loanable funds by the banks. It is also reflected in terms of economic performance and consequent pressure for credit support. Now that the economy has picked up with an estimated GDP growth rate of 8.0%, simultaneously it has led to increased pressure on credit support. The credit-deposit ratio has gone up to 80% in January 2024 which exceeded the bank’s loanable funds limit of 77.5%.

Banks are subject to penalties when their credit-to-deposit ratio exceeds the permissible limit. To avoid penalties, the banks resort to inter-bank transactions which is evident from the increase in weighted average call money rate (WACR). WACR was 3.07% on January 21, 2022, and reached 6.19% on January 20, 2023. Since then, it has continued to rise, reaching 6.65 on 26th April 2024.

Pressure on bank credit should be handled with a positive approach instead of looking at this as a crisis. The crucial juncture of India's striving to maintain the growth tempo with a clear target of becoming the third-largest economy by 2027, certainly doesn’t permit an idea of denying credit support to the stakeholders as it may have adverse consequences. What is the way out?

Stepping up of Deposits
The immediate option is attracting deposits through a hike in interest rates. High interest rates are likely to incentivize investors especially, marginal savers to increase their bank deposits. The weighted average deposit rates offered by scheduled commercial banks on fresh deposits have experienced a steady increase since May 2022 as it has gone up from 4.07% in May 2022 to 6.97% in March 2024.

The interest rate on one-year term deposits has gone up from 6.00-7.25% to 6.5-7.25% range during the period. Nevertheless, the weighted average lending rate for fresh loans has risen modestly from 7.86% in May 2022 to 9.37% in March 2024. Consequences: if the lending rate is raised to recover the interest expenses then it will lead to an increase in the cost of borrowing and may lead to operational costs in the economy with inflationary pressure. Alternatively, if the lending rate is not raised, the profit margin of the banks is bound to narrow down.

Monetary Policy Tweaking
As a short-term measure, the RBI can resort to open-market operations, specifically, through the purchase of T-bills from the banks it can inject liquidity into the banking system. The recent data indicates that the RBI has purchased bonds mainly in 2020 and 2021 following the occurrence of the COVID-19 pandemic. Rather it has sold bonds in 2022 and 2023 in sync with its tight monetary policy approach.

The best option is to look at the reserve ratio norms. As of now, the prevailing reserve ratios i.e., CRR and SLR are 4.5% and 18% respectively. While reducing the CRR is not feasible as these funds must be kept aside by banks for precautionary purposes, SLR can be reduced. The RBI has gradually decreased the SLR from a peak of 38% in 1991 to its current level of 18%. The reduction of SLR can increase liquidity in the system.

For instance, as of 31st March 2024, aggregate deposits in the banking system stood at Rs 200,59,152 crores out of which Rs 155,45,843 is available for lending purposes after keeping aside 18% SLR + 4.5% CRR. If the SLR is reduced by 1%, then the loanable fund will increase by Rs 2,00,591 crores to Rs 1,57,46,434.32 crores.

It will lead to an increase in the loanable funds with banks and consequently decrease in the cost of borrowing which in turn will lead to more private investment in the economy. However, the million-dollar question is whether the central bank would like to narrow down the scope for the government to get its market borrowing accommodated comfortably through the obligatory SLR route.

(Dr. Jagadish Shettigar is former Member of the Prime Minister’s Economic Advisory Council & Visiting Professor in Economics at BIMTECH; Riya Bindra is Research Scholar in Economics at BIMTECH; Views are personal)