Why is Kamath’s hypothesis on bank deposits exploding?

In fact, veteran banker KV Kamath provided a healing balm at Mint’s annual banking conclave on January 12. He argued that bank deposits are intrinsically safe and will grow in double digits which should be enough to meet credit demand. He has got a point. So this may be an opportunity to open up some layers in the credit-deposit dynamic of the commercial banking system.

But first some basic data.

The latest data from the Reserve Bank of India (RBI), available as of December 30, shows a 14.9% year-on-year growth in total credit, with deposit growth at 9.2%, well ahead of Kamath’s forecast of double-digit growth. It is only a little less. The uneven growth between credit and deposits can be gauged from how the indicator, the credit-deposit ratio, has grown over the past year: it stood at 75.02 as on December 30, as against 71.94 at the same time a year ago. The volatility of this major ratio also indicates that the growth in the numerator (credits) has outpaced the growth in the denominator (deposits) over the past 12 months.

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There are several valid reasons for the slow growth in deposits, one of them being the long tail of the pandemic. The Covid pandemic was preceded by a concerted move by the RBI since 2018 to reduce interest rates; The outbreak of the pandemic forced the central bank not only to reduce rates but also to keep the system awash in surplus liquidity. As a result, the returns on bank deposits turned negative after adjusting for inflation and taxes. This became a problem for many middle-class families, especially retired families, who depended on monthly interest rate income.

Around the same time, almost coincidentally, stock market indices rallied. The shockwaves of the pandemic and the coordinated global lockdown initially spooked the markets, leading to a fall in the indices. But once the markets were convinced that Armageddon had been averted, that the end of the world had been postponed, the markets recovered sharply. This diverted surplus domestic cash flow from banks to the markets, some directly and some indirectly through mutual funds and other financial institutions.

But as broken supply chains pushed up price levels, along with increased demand from Russian troops marching into Ukraine in February 2022, central banks around the world began raising interest rates. Domestically, even the RBI hiked rates by 225 basis points in five steps. Commercial banks also had to readjust their loan and deposit rates. However, the art of banking requires that banks lower deposit rates faster than they raise them; This is the reverse in credit where banks are slow to cut rates but are quick to raise lending rates.

So it is a matter of time that interest rates stabilize at a rate at which returns can be positive, even if they are marginal. And this is where Kamath’s hypothesis begins. He had said at the Banking Conclave that banks would experience double-digit deposit growth – 10-15% growth depending on the bank – on an estimated gross domestic product growth for FY24 due to overall banking growth in the country. He also felt that deposit growth would be driven by intrinsic consumer confidence in the banking system, backed by a strong and credible regulator (read RBI).

The three years since January 2020 have seen their share of frauds and fly-by-night operators, especially from nefarious crypto exchanges and bent fintech providers. The RBI has been consistently warning customers about the pitfalls of engaging in alternative financial products, especially those without a regulatory backstop, and has demonstrated its resolve by taking prompt action against errant bankers and other delinquent financial sector intermediaries. .

So far, so good. What could spoil the party, however, is the retail sector’s newfound appetite for credit. In the past two years, commercial banks have seen loan growth due to demand from retail consumers and non-banking finance companies (which then lend the same money to retail borrowers). A good portion of this money is suspected to have been invested in speculative avenues (such as the stock market and property) and banks will have to demand additional equity or margin from these borrowers in order to accommodate rising interest rates. This is usually when it all breaks down; RBI has been warning about this phenomenon in its latest annual and half-yearly publications as well. Credit growth or deposit growth concerns will then take a backseat to entirely new concerns.

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