The Deposit Issue: Why Banks are Struggling to Lend

What’s in today’s article?

• Introduction
• Growth Driven by Government Spending
• Widening Credit Gap
• Changing Investment Habits and Impact on Deposits
• Private Sector Investment Cycle
• Conclusion

Introduction

• India is among the fastest-growing large economies, driven largely by the Central government’s increased expenditure on infrastructure.
• However, challenges such as job creation and subdued private investment persist, as highlighted in recent reports by the World Bank and the Economic Survey 2023-2024.

Growth Driven by Government Spending

• The government’s capital expenditure has significantly boosted the productive potential of the economy.
• However, private investment, crucial for job creation, has been mediocre.
• In the fourth quarter of FY24, private Gross Fixed Capital Formation fell to a four-quarter low of 6.46%, down from 9.7% in the previous quarter.
  • Gross Fixed Capital Formation (GFCF) is a measure of how much money is being invested in physical assets like buildings, machinery, equipment, and infrastructure within an economy.
  • It represents the net increase in a country’s stock of fixed assets, which are essential for production and economic growth.
• Between FY19 and FY23, the share of private non-financial corporations in GFCF increased marginally from 34.1% to 34.9%.
• The government has urged the private sector to take the lead in driving growth.

Widening Credit Gap

• A key issue impacting private investment is the reduced risk appetite of banks to lend to the private sector.
• S&P Global predicts that credit growth will decline to 14% in the current financial year, down from 16% last year.
• A growing gap between credit and deposit growth is creating a liquidity crunch, with deposit growth averaging 11.1% over the past two years, compared to 16.8% credit growth.
• This gap has been exacerbated by the declining share of Current and Savings Accounts (CASA) in total deposits.
• Lagging Behind Asian Peers:
  • India's credit-to-GDP ratio is lower than other Asian countries with similar income levels, such as Thailand, Malaysia, and China.
  • This lag is partly due to stricter regulatory requirements, such as the proposed Liquidity Coverage Ratio guidelines, which could further impede credit growth.
    • The Liquidity Coverage Ratio (LCR) is a financial rule that requires banks to hold a certain amount of high-quality liquid assets (like cash or government bonds) that can be easily sold.
    • The purpose of the LCR is to ensure that banks have enough liquid assets to cover their short-term obligations in times of financial stress, specifically for 30 days.

Changing Investment Habits and Impact on Deposits

• Households are increasingly investing in capital markets rather than traditional bank deposits, driven by the post-pandemic rise in market returns.
• This shift is altering the composition of deposits, affecting the money multiplier and deposit creation processes.
• Additionally, reduced government spending in the lead-up to elections has exacerbated the deposit crunch, with government cash balances at the RBI rising significantly.

Private Sector Investment Cycle

• S&P Global notes early signs of a revival in private sector investment, spurred by government spending on infrastructure and a rebound in the housing sector.
• However, there is a long way to go for a broad-based recovery.
• Despite measures like corporate tax cuts in 2019 and the introduction of the Production Linked Investment (PLI) scheme, corporate tax contributions to government revenue have not increased proportionately.

Conclusion

• While India’s economy continues to grow rapidly, challenges such as low private investment, a widening credit-deposit gap, and changing investment habits pose significant risks.
• Addressing these issues will be crucial to sustaining growth and achieving a balanced economic recovery.

Q1. What do you mean by Repo Rate?

Repo Rate is the rate at which the Reserve Bank of India (RBI) lends money to commercial banks or financial institutions in India against government securities. The current Repo Rate in 2023 is 6.50%. If the RBI lowers the Repo Rate, it increases the money supply in the market, which can help the economy grow.

Q2. What is Bank Rate?

A bank rate is the interest rate at which a nation's central bank lends money to domestic banks, often in the form of very short-term loans.

Source: The deposit issue: Why banks are struggling to lend