Indian banks are in a balancing act during FY24. On one hand, they’re witnessing a surge in credit growth, a sign of a reviving economy. But on the other hand, deposit growth isn’t keeping up, creating a liquidity squeeze. The answer? Banks are raising deposit rates to attract more funds.
Credit Growth Outpaces Deposits
Swaminathan Padmanabhan highlights that credit growth in India is currently at a robust 20.2%, year-on-year. That’s fantastic news for businesses and individuals looking for loans. However, deposit growth is lagging at just 13.5%. This mismatch means banks have less money available to lend out.
Deposit Rates – A Double-Edged Sword
To bridge this gap, banks are raising deposit rates. While this attracts new depositors, it also comes at a cost. Banks typically offer lower interest rates on deposits compared to other sources of capital, like debt instruments. So, higher deposit rates eat into their profits.
Impact on Banks Profitability
Imagine this: a 100 basis point hike in deposit rates could potentially shave off 20-25 basis points from net interest margins. That’s a direct hit to a bank’s profitability, especially when the repo rate (the rate at which RBI lends to banks) has been stable at 6.5% since February 2023.
Why This Matters for the Economy
A healthy banking sector is vital for a growing economy. Banks act like pipelines, channeling credit to businesses and individuals. If banks become strained due to lower profitability, their ability to lend could suffer. This, in turn, could slow down economic growth.
Deposit Rates vs. Lending Rates
There’s a sweet spot for deposit and lending rates relative to the repo rate. Ideally, they should stay within a specific range to ensure both profitability and sustainable growth for banks. A widening gap between these rates could threaten financial stability and hinder long-term economic progress.
The Need for an RBI Rate Cut
Swaminathan Padmanabhan suggests that a well-timed reduction in interest rates by the Reserve Bank of India (RBI) could be the answer. This would help banks manage their profitability better and ensure the smooth flow of credit in the economy. It’s important to remember that India’s economic situation is unique, and its interest rate scenario may not necessarily follow the same path as western economies.