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Posted by: Deepa Vasudevan on Wed, Nov 14th, 2012

The Widening Credit-Deposit Wedge

The Widening Credit-Deposit Wedge


The RBI has repeatedly pointed to the "widening wedge" between credit growth and deposit growth as one of the reasons for the liquidity deficit in the system. This phrase and its history need some explanation.

 

Banks take deposits and on-lend them to households, corporate, and other economic entities.  A part of bank funds are impounded by the government through CRR and the SLR. The remaining is available for direct lending or investment. Pic 1 shows the difference between total deposits (source of funds) and the sum of total bank credit and investment (uses of funds) over the last 40 years. In 2002-03, the gap turned negative- indicating that banks needed more than just deposit funds to meet demand for credit and investment. By 2011-12, the gap was at minus 8,51,400 crore. Just to put that shortfall into perspective, deposits funded only 88.3% of loans and investment in that year, the lowest ever level since 1970-71 (the average over that period was 98.8%!).

 

Pic 1: Bank Deposits and Use of Funds

Bank Deposits and Use of Funds

Source: RBI

 

The credit deposit wedge has risen in the last four years, despite sluggish credit offtake, because deposit growth has been very poor. A disaggregation of deposits shows that the share of the cheapest deposits- current and savings account (CASA)- has reduced to about one third; the highest cost Certificate of Deposits (CDs) form about 7% of total deposits. This has two immediate implications for banks.

 

First, the higher cost of funds reduces bank spreads; RBI data show that average spreads of SCBs have fallen by 7 basis points in 2011-12. That is not too bad given the current challenging operating environment. But if policy rates are cut in January 2013 as anticipated, bank deposits may become even less attractive, and spreads may narrow further.

 

Second, banks are patching up the wedge by taking recourse to borrowings, which now form about 10% of total bank liabilities. Over half of these borrowings are short term, whereas bank loans tend to be concentrated in the 1-3 year maturity.  This raises issues of asset-liability mismatch.  Of the Rs.8401 billion borrowed by SCBs in 2011-12, 45% was borrowed outside India, and 40% was borrowed from institutions other than banks and RBI. Further details are not publicly available.

 

None of this amounts to a banking crisis. It is, however, an indication that banks need to take stock of their sources of funds. The Indian banking system consists of three groups: public sector banks, private banks, and foreign banks. Each banking group has seen a widening of the credit-deposit wedge. But public sector banks, which garner 75% of total deposits, tend to be the most affected by declining deposits. With monetary easing imminent, it is even more important to mobilise low-cost deposits.  Recently the SBI Chairman urged a review of minimum deposit maturity norms to incentivise short term inflows; such suggestions reflect, probably, an urgent need to improve mobilisation.

 

Monetary policy actions often focus on improving credit flow and managing the quality of loan assets. Perhaps it is time to give some thought to the impact of policy on bank liabilities.  

Girish Wani on Wed, Nov 21st, 2012 12:00:04 pm

Nice article... I think this gap is going to widen only as economy matures , for investments or deposits people and corporates have other options than bank deposits, but for loans their are very few options other than banks..Till 2001-2002 only source for deposits or investments was banks...

Porus Paghdiwalla on Tue, Nov 20th, 2012 4:15:11 pm

Indeed a thoughtfull article and gery area for all ALM Committe's . I think that this problem needs to be addressed very seriously by RBI but it requires a bilatral solution and not a unilateral RBI Policy or Guidline. MOre ever with the fast spreading Investor Awarness and every individual wants to earn maximum form every rupee invested . and today Liquid funds offer the conviniace of a Savings AC but one earns almost double the Interest oferred on SB AC Regards Porus Paghdiwalla

Deepa Vasudevan on Mon, Nov 19th, 2012 2:23:36 pm

Dear Mr.Mishra, I agree with the your reasons for declining deposits. The high inflation and overall economic uncertainty of the past two years have only reduced investor appetite for bank deposits; they prefer higher return short term instruments. If banks wish to mobilize more money, especially from the rural areas, they need to come up with innovative strategies.

Deepa Vasudevan on Mon, Nov 19th, 2012 1:09:25 pm

Hi Deepak, Thanks for your comment, I follow your blog regularly so it is great to hear from you! You are absolutely right about borrowings being lower cost than deposits - in fact RBI reports state that avg borrowing costs are about 3-%4% lower than avg costs of deposits. Also, as you point out, short term deposits are as bad for ALM as short term borrowings. The purpose of this blog was simply to show that the structure of bank liabilities is changing. This raises some questions such as: 1. Agreed investors are smartly allocating some CASA money to MMMFs and bond funds. If this is an obvious trend in an evolving financial system, then why worry about the credit-deposit wedge? No less than the RBI governor, and the SBI chairman have publicly expressed concern about it. Why not, instead, make it easy for banks to take on more borrowings by easing regulations some more? Is the ability of banks to negotiate fine rates overseas or hedge intelligently in doubt? Or is borrowing restricted by poor asset quality? 2.There should be more information about borrowings. Who are the lenders in the domestic/overseas markets, what are the rates, what maturities etc. Foreign banks have always had plenty of non-deposit sources of funds in their balance sheets; but this is a recent trend for public sector banks. All the more reason for more details to be made available!

SRIMANT MISHRA on Sun, Nov 18th, 2012 12:27:34 pm

To me following are the reasons for fall in CASA(current & saving A/c): 1.Increase in minimum balance in saving A/c. 2.Low rate of interest in comparison to Liquid fund of Mutual Funds. 3.Banking marketing personnel are having immense pressure to sell Insurance & other financial products. 4.Less motivated staff force in PSU Banks.

Deepak Shenoy on Sat, Nov 17th, 2012 10:19:18 pm

Deepa, Interesting analysis, thanks. My notes: AL Mismatches aren't exacerbated by borrowing through wholesale markets (i.e. CDs and bonds) - you could have a huge AL mismatch just because of your deposit fit. AL mismatches can be mitigated in different ways, but a focus on deposits will still result in them. Banks have always made money by borrowing short and lending long; and there are metrics to track and address large gaps (structural liquidity etc) plus banks have access to the lender of last resort. Second, the move to borrowings is not bad. With the move to an online medium today, deposits can be cut and moved out just as well as anything else. Given that, it's a larger risk than a bond issue where the bank has zero early termination risk. And secondly, it's great for investors who don't have to have tax deducted at source, and don't have a penalty for early withdrawal. Finally, it's very low cost compared to deposits, and you can actually use swaps to mitigate interest rate risks which appear in a cash flow or structural liquidity analysis. Third, much of the move to market borrowings have come because of the opening of regulations by RBI recently. With a better bond market now than earlier, and the ability for banks to borrow abroad (and hedge!) there is no need for banks to focus only on CASA and/or deposits; in fact, as people get more and more aware of better options like bond funds and short term liquid funds, they will take money out of CASA. Banks should preempt and immerse themselves into bond markets as soon as possible. Just my 2 paise.

Deepa Vasudevan on Fri, Nov 16th, 2012 4:07:20 pm

Dear Anshuman, You have correctly identified some solutions. Deposits need to be mobilized, especially low cost ones. And this must be accompanied by robust credit growth- not just loans for restructuring!

Deepa Vasudevan on Fri, Nov 16th, 2012 4:06:25 pm

Dear Mr. Kartha, The impact of a probable rate cut in January 2013 depends on whether industrial activity picks up or not. If rates are cut, deposit rates and lending rates will both fall. That might reduce deposit mobilization even more. And, if credit off take picks up strongly, then the wedge will widen even more! So the only way seems to be to garner more deposits using innovative techniques. Admittedly tough, given declining savings and high inflation. So this is an issue that needs to be debated and addressed quickly. As for your second question, investment is a small part of total uses of funds when we see the total amount for the banking sector. But it is relevant for non-PSB banks such as foreign banks where investment almost equals bank credit.

Prakash K Kartha on Fri, Nov 16th, 2012 10:42:10 am

If there is a rate cut in Jan 2013 as anticipated, what could be the probable impact on wedge widening, when investment may become less attractive? Whether, the data on Investment by the bank vs Bank Credit (within "Total Use of Funds") has any relevance?

ANSHUMAN MOHANTY on Fri, Nov 16th, 2012 10:10:20 am

Banks need to urgently step the building up the low cost deposit,i.e,build up CASA balance.Customers today are aware and awake.The Bank need to come up with Products and Features that makes sense for retail customers to transact through a specific Bank. Banks has to be cost effective.Transaction costs to be brought down.Retail customers to be encouraged to use Direct Banking channels. The deposit balance sheet must be monitored and should encompass broad segment. Financial inclusion in its true sense would help the Bank build up a diversified deposit base and reducing risk of major outflow.Credit growth also need to move in tandem.Its imperative that both deposit and credit grow by strong retailing but also the portfolio of the both deposit and credit must be well diversified .This will check risk deposit outflow and hence a healthy credit strategy can be build up which will entail a strong credit growth by inclusion of participative credit growth. The mantra is strong retailing of deposit and participative strong credit growth bulit up by lowering cost of transaction and risk of default.

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