Banks may have to borrow more as deposit growth slows down, with share of low-cost deposits hitting a two-decade low in FY24: Fitch

Key points of Fitch Ratings report.

• The share of Indian banks’ borrowings will continue to rise gradually within their overall funding mix if they struggle to attract sufficient fresh deposits to support loan growth.
• At the same time, a sustained capital-market performance could accelerate the shift of retail savings to investments (in the stock markets).
• The recent sharp rise in the loan-to-deposit ratio (LDR) could become a structural issue if low returns on deposits amid inflationary pressures – and evolving depositor preferences – hinder long-term deposit growth.
• Bank deposit rates have been slow to respond to the sharp 250 bps increase in policy rates during the financial year ended March 2023 (FY23), with term deposit rates to fully reflect this change as of Q1 of FY25.
• The return on low-cost deposits remains unchanged, leading to their share in new deposits hitting a two-decade low of 20 per cent in FY24, according to Fitch’s estimate.

This could put pressure on funding costs over the medium term. Low-cost deposits’ migration to term deposits is usual under high interest rates, but the former’s share in fresh deposits fell to 20 per cent in the financial year ended March 2024 (FY24), a two-decade low.

About Low-cost deposits:

It refer to bank deposits that incur minimal interest expenses for the bank, meaning the bank pays little to no interest to the depositors while using the funds to lend out and generate profit. These deposits are crucial for banks as they help maintain profitability by reducing the cost of acquiring funds for lending and other financial activities.

Types of Low-Cost Deposits

The main types of low-cost deposits are:

1. Current Accounts: These are non-interest-bearing accounts typically used by businesses for frequent transactions. Banks do not pay interest on current accounts but still use the funds to lend or invest.
2. Savings Accounts: While banks pay interest on savings accounts, the rate is usually much lower compared to other deposit products, making them relatively low-cost for banks. Savings accounts are popular among individual customers for holding their savings while earning some interest.

Significance of Low-Cost Deposits in the Economy

1. Profitability for Banks:
   • Banks prefer low-cost deposits because they reduce the overall cost of funds. By paying little to no interest on these deposits, banks can increase their interest margin (the difference between what they earn on loans and what they pay on deposits).
   • These deposits allow banks to lend more at higher interest rates, thus boosting profitability.
2. Liquidity and Stability:
   • Low-cost deposits provide banks with a stable source of liquidity, as current and savings accounts tend to have less volatile withdrawal patterns compared to fixed deposits or term loans. This helps banks manage liquidity better and meet regulatory requirements.
   • Stable deposits also help in ensuring that banks can meet any unexpected surge in withdrawal demands without liquidity crises.
3. Economic Growth:
   • Since low-cost deposits are a cheaper source of funding for banks, they enable banks to lend at lower interest rates, promoting credit availability to businesses and individuals. This can lead to increased investment, business expansion, and economic growth.
   • By offering cheaper credit, banks can stimulate consumption and boost various sectors of the economy, such as housing, manufacturing, and services.
4. Financial Inclusion:
   • Low-cost deposits, particularly savings accounts, are important for promoting financial inclusion, as they provide an accessible entry point for low-income individuals to join the formal banking system. Various government schemes like Jan Dhan Yojana encourage savings account openings, helping bring the unbanked population into the financial system.
5. Risk Management:
   • Having a strong base of low-cost deposits helps banks maintain a lower loan-to-deposit ratio (LDR), improving liquidity management. This reduces the risk of a mismatch between loans and available funds and prevents over-lending.