Contrary to popular perception, interest rates alone don’t move the needle towards high bank deposits. Instead, economic growth rate and disposable incomes hold the key for higher deposit mobilisation, says an RBI study. Typically, bank deposits are a function of interest rate and income, although other factors are also being considered recently. A positive relationship between bank branches and deposits has been confirmed, making the case for bank branch expansion in unbanked areas. Returns on Sensex, inflation and interest rate on the provident fund also impact the growth of time deposits.
However, the study titled ‘Bank deposits: Underlying Dynamics,’ revealed that income and financial inclusion are long-term structural drivers, while interest rate and Sensex returns impact deposit growth in the short-run. Interestingly, substitution effects associated with Sensex returns for deposit growth are limited in the short-run, warranting a careful appraisal of regulatory reforms and tax arbitrage, even as efforts need to be intensified to make both more markets determined.
Similar to Sensex returns, small savings substitute bank deposits in the short-run but supplement deposits in the long-run, reflecting that limits on income tax exemption eventually evens out substitution effects and allow income to be the key determinant of both in the long-run. Notwithstanding the rise of alternative financial products, bank deposits continue to remain households’ preferred financial asset.
Deposit mobilisation is fundamental to India’s bank-based system of financial intermediation and the prevailing slowdown at a time when credit demand is increasing, raises concerns about a structural liquidity gap, possibly amplified by substitution effects of small savings and mutual funds. After a 75-month prolonged deceleration, bank credit growth rose to 9.3 per cent in November 2017, from an all-time low of 4.4 per cent in February 2017.
The widening wedge between credit and deposit growth triggered concerns about a structural liquidity gap, which can throw sand in the wheels of the financial intermediation process through which deposits are converted into productive investments by way of lending, thereby greasing the wheels of the economy, the study noted.
As on March 2019, outstanding deposits stood at `125.726 lakh crore, accounting for 129 per cent of outstanding bank credit (lower than 132 per cent a year ago), reflecting the tightening of financial conditions on account of low deposit growth. Deposits mobilised by public sector banks appear to be the prime mover of aggregate deposits. Both private and foreign banks are sharing the recent pick up in deposit growth, with foreign banks posting a smart upturn from a contraction in October 2011 and private banks appearing resilient with deposit growth picking up from September 2013.
How bank deposit patterns pan out
Deposit liabilities payable on demand like current account deposits and demand component of savings deposits are covered under demand deposits. Time deposits include fixed deposits and time component of savings deposits. Over time, share of demand deposits have declined, with the latter accounting for around 88 per cent of aggregate deposits, whose growth is mainly determined by time deposit behaviour. On the other hand, demand deposit growth is volatile, presently in consonance with changes in currency with the public.