Banks need to increase borrowing as deposit growth slows; low-cost deposits at lowest in 20 years

According to a recent report by Fitch Ratings, Indian banks are expected to experience a gradual increase in the share of borrowings within their overall funding mix if they continue to face difficulties in attracting fresh deposits to sustain loan growth. This was reported by The Indian Express. The report further highlighted that strong performance in capital markets could lead to a shift in retail savings from traditional bank deposits to stock market investments. Fitch expressed concern over the rising loan-to-deposit ratio (LDR), which could evolve into a structural issue if low returns on deposits—alongside inflationary pressures and changing depositor preferences—limit the long-term growth of deposits, The Indian Express reported.

The current share of borrowings stands at around 10%, but this could increase if banks are unable to attract sufficient low-cost, long-term resources to fund loan growth, according to the report. Despite a 250 basis point increase in policy rates during the financial year ending in March 2023, deposit rates have been slow to rise. Fitch noted that the impact on term deposits will only fully materialize by the first quarter of FY25, while the return on low-cost deposits has remained unchanged. Consequently, the share of low-cost deposits in fresh deposits has dropped to 20%, a two-decade low in FY24. This trend could lead to rising funding costs in the medium term. Although it is typical for low-cost deposits to shift toward term deposits in a high-interest-rate environment, Fitch cautioned that their reduced share could create future challenges. "Inflationary pressures, growing digitalisation, and strong capital-market performance may further encourage depositors to move away from bank deposits toward investments," Fitch stated in the report. This shift poses risks to banks' funding strategies and could complicate asset-liability management if long-term funding options do not compensate for the loss of deposits.

While Fitch does not anticipate immediate changes to banks' Viability Ratings, significant shifts in funding strategies that increase margin pressures or affect growth and liquidity could lead to a reassessment of individual key rating factors. Fitch also noted that term deposit rates have only risen by 234 basis points since March 2022, while the returns on low-cost deposits have not changed. The agency warned that the sharp rise in the LDR could become a long-term concern if deposit growth is constrained due to low or negative real returns on deposits amidst inflationary pressures, combined with high loan growth.

Deposit growth has matched loan growth with a compound annual growth rate (CAGR) of 9.4% between FY14 and FY24. However, since FY21, the LDR has climbed by 10 percentage points. As liquidity excesses normalize, banks must focus on growing deposits to reduce reliance on borrowing, Fitch emphasized. The report also described the current deposit pricing strategy as unsustainable over the long term, given the economy's heavy reliance on bank credit. Meanwhile, mutual fund investments have grown at a 24% CAGR since FY17, and a sustained capital-market boom could accelerate the transition of retail savings from bank deposits to investments. Demographic shifts and the growing use of digital platforms are also expected to contribute to this trend.

Fitch warned that continued increases in the LDR could intensify margin pressures beyond their current projections. Given banks' limited pricing power, they may struggle to pass on rising funding costs without taking on additional risks. Fitch noted that easing liquidity from the Reserve Bank of India or an increase in government-linked inflows could help alleviate pressure, as seen in the past. However, if real returns on deposits remain low, this could put additional pressure on the LDR and make asset-liability management more difficult. Expanding the depositor base beyond the top 15 urban centres, which account for 65% of mutual fund assets and 44% of bank deposits, could help banks retain deposits.