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

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, it said.

“Factors such as inflationary pressures, increasing digitalisation, and strong capital-market performance may further drive depositors to shift from bank deposits towards investments,” Fitch said. This trend poses a risk to funding costs, and could render asset-liability management more challenging if banks’ long-term funding does not plug the gap from any migrating deposits, it said.
Fitch does not expect any near-term rating changes due to adequate headroom in Viability Ratings, but significant funding changes that intensify margin pressure beyond Fitch’s base case – or have an impact on banks’ growth and liquidity management – may necessitate reassessment of individual key rating factor scores, the rating firm said.

Term deposit rates have risen by only 234 bps since March 2022, while low-cost deposits rates remain unchanged. “There is a risk that the recent sharp rise in the loan-to-deposit ratio (LDR) may persist as a structural issue if future deposit growth is constrained – due to low/negative real return on deposits and evolving depositor preferences amid inflationary pressures, and high loan growth,” Fitch said.

Deposit growth matched loan growth at a 9.4 per cent CAGR between FY14-FY24, but LDR has risen by 10 percentage points since FY21. Normalisation of previous liquidity excesses necessitates that banks focus on growing deposits, Fitch said.

Fitch considers banks’ current deposit pricing strategy unsustainable over the long term, if deposits must support the economy’s high reliance on bank credit.

Meanwhile, mutual fund (MF) investments have grown by a 24 per cent CAGR since FY17. Sustained capital-market performance could accelerate the shift of retail savings to investments. Demographic shifts and digitisation may also spur the move away from bank deposits, the rating firm said. “A continued sharp rise in the LDR could intensify margin pressure beyond Fitch’s expectations. Indian banks have limited pricing power, which may prevent full pass-through of increased funding costs without additional risk-taking.”

Fitch said sustained easing of the Reserve Bank of India’s liquidity stance, or higher government-linked inflows, could ease pressure, as in the past, but declining flows due to lower real return on deposits could raise pressure on LDR and asset/liability management.

A widening of the depositor base from the top 15 urban centres – 65 per cent of MF assets, 44 per cent of bank deposits – could augment inflows and support banks’ deposit retention.