Bank Deposit Rates Unlikely to Decline Amid Strong Loan Demand
Bank deposit interest rates in India are expected to remain steady through the remainder of FY25 as banks grapple with heightened credit demand and tighter liquidity conditions. Despite a recent cut in the cash reserve ratio (CRR) by the Reserve Bank of India (RBI), lenders are unlikely to lower deposit rates significantly, given the need to mobilize funds for a seasonally strong credit demand in the fourth quarter.
CRR Cut Offers Limited Relief
The RBI’s reduction in the CRR by 50 basis points earlier this month released an estimated ₹1.16 lakh crore into the banking system, temporarily easing liquidity pressures. However, this move is insufficient to offset broader systemic liquidity challenges. “While system liquidity is likely to continue to be in deficit in December 2024, the recent CRR cut by the RBI should provide some relief. Deposit rates are unlikely to show a material decline as the busy credit season lies ahead,” noted Karan Gupta, Director – Financial Institutions at India Ratings.
Liquidity Challenges Persist
As of mid-December, the banking system’s liquidity situation has deteriorated significantly. Liquidity swung from an average surplus of ₹25,000 crore in early December to a deficit of ₹1.11 lakh crore by December 16. This steep decline was largely attributed to quarterly advance tax payments by corporates, which drained liquidity from the system. The persistent deficit is expected to keep short-term rates elevated, with experts noting an increase of 5-10 basis points in short-term borrowing costs compared to early December levels.
Deposit Growth Matches Credit Growth
On the deposit side, growth has finally converged with credit growth, both clocking an annual increase of 10.6% and 10.7%, respectively, as of November 29. This convergence is a positive development for the banking system, as it alleviates the earlier mismatch between credit expansion and deposit mobilization. Nonetheless, maintaining this balance is critical, especially during periods of heightened loan demand.
Credit Demand Peaks in Q4
Traditionally, the fourth quarter sees a surge in credit demand driven by working capital requirements and seasonal business needs. This year is no different, with the banking system reporting a year-on-year credit growth of 10.6% as of November-end. Although this is a moderation from the double-digit growth observed earlier in FY25, the demand remains robust enough to exert pressure on banks to sustain elevated deposit rates to attract funds.
Marginal Impact on Bank Margins
The CRR cut has a nuanced impact on bank profitability. According to Soumya Kanti Ghosh, Group Chief Economic Adviser at the State Bank of India, “The reduction in CRR may not mathematically translate to any change in deposits and lending rates. However, it may have a positive impact on margins of 3-4 basis points for banks.” This modest improvement in margins provides some relief but does not fundamentally alter the funding cost dynamics for banks.
Rising Reliance on High-Cost Funding
To meet funding requirements, banks have intensified their efforts to attract deposits by offering higher term deposit rates. Additionally, many lenders have turned to certificates of deposit (CDs), a relatively costlier funding avenue, to bridge liquidity gaps. “Deposits have remained prominent in FY25 as banks have intensified efforts to strengthen their liability franchise and have offered higher term deposit rates,” said Sanjay Agarwal, Senior Director at CARE Ratings. “The banks are additionally obtaining funds through certificates of deposit, albeit at a comparatively higher expense.”
Funding Conditions to Remain Tight
Experts broadly agree that funding conditions for banks will remain tight in the foreseeable future. While deposit rates have likely peaked, they are expected to stay elevated as banks compete to secure funds amid volatile liquidity conditions and strong credit demand. The need to maintain an adequate liability base to support credit growth means that any reduction in deposit rates is unlikely before the end of FY25.
Implications for Borrowers and Depositors
For borrowers, the stable to marginally higher interest rate environment could mean higher borrowing costs, especially for short-term credit facilities. On the other hand, depositors stand to benefit from attractive term deposit rates, as banks continue to offer competitive returns to secure funds.
Outlook for FY26
As we approach the end of FY25, the outlook for FY26 hinges on several factors, including RBI’s monetary policy stance, global interest rate trends, and domestic economic conditions. If liquidity conditions improve and credit growth stabilizes, there may be room for banks to reassess deposit rates. However, the current environment suggests that deposit rates will remain a focal point for banks to navigate through the immediate challenges.
In summary, while the CRR cut has provided temporary relief, the interplay of strong credit demand, volatile liquidity conditions, and external pressures will likely keep deposit rates elevated in the near term. Banks will need to carefully manage their funding strategies to sustain growth and profitability in this challenging environment.
The image added is for representation purposes only
