Widening Deposit-Credit Gap is Indicative of India's Financial Vulnerability

New Delhi - 20 Mar 2022 - Reserve Bank of India, RBI logo on the closed iron gate of New Delhi branch. Image used for representation only.

(Photo: iStock)

According to the data, a worrying macroeconomic reality is brewing for India’s already fragile financial sector, ridden by Non-Performing Assets (NPAs), debt (and insolvency) — a low deposits growth rate that is being outpaced by the credit growth rate.  

In June, bank deposits grew at less than 11 percent, whereas bank loans grew at around 14 percent. As of 9 August, bank deposits had shown a yearly growth of 11.7 percent, whereas bank loans had grown 18.4 percent.   

In short, the demand for credit is much higher than the actual deposits with the banks. In such a situation, the banks, especially public sector banks, may face liquidity issues and challenges in meeting withdrawal demands due to insufficient deposits.  

There is also the possibility of increased NPAs as rapid loan growth can lead to a higher risk of defaults, which in turn could trigger greater financial instability and a potential strain on the banking sector's stability.

It is true that the mechanics work quite differently than the textbook definition of credit creation. Still, deposit strength provides a cushion to banks, particularly in times of financial uncertainty and economic volatility. The loan creation process is also circumscribed by the amount of financial capital that a bank has.  

As argued here, “lending is also limited by the confidence that a bank needs to have while giving out a loan, that the loan is more than likely to be repaid. Or if I were to put it slightly technically, there are only so many prime borrowers out there.” 

This author has earlier argued (see here, here, and here) that the Indian economy if viewed from the circular flow system of different stakeholders (from the household level to the firm and government level), is facing a substantial ‘hidden’ debt crisis, worsened by macro-Keynesian aggregates that haven’t performed well (savings, investment, employment, new capacity or productivity creation).

Debt may be less visible in macro trends but it is actually ballooning over time, as private investment remains low, and real incomes and employment growth (across sectors) stagnate or operate at sub-optimal levels. The divergence emerging in the deposit-credit growth rates is a significant marker in explaining this debt-like bubble, like a crisis envelope on India’s macroeconomic status quo.  

It’s true that compared to many other emerging market economies, India’s macro position may be relatively better placed, but beneath the shiny armour and bonnet, the engine and semi-automotive parts driving the Indian economy appear to be at a vulnerable point.   

The finance minister recently asked the banks to set up deposit mobilisation efforts and undertake special drives to address the issue.

This fails to even acknowledge the underlying fundamentals of banking behaviour, the conscious pivot towards finalisation of credit (which the banks have adopted), accompanied by an indifferent approach towards the problems associated with other intersectional aggregates (lower saving rates and lower disposable incomes) that contribute to lower deposit rates.  

Soumya Kanti Ghosh recently blamed the slowdown in deposit growth on the leakages of money from the financial system “including the way the union government now disburses money under the centrally sponsored schemes that have a matching share by the state government, in a just-in-time manner.”  

As Vivek Kaul argues (and I agree with him here), “I haven’t been able to get my head around this argument completely, because this money, even though delayed, does ultimately reach the banking system.”  

Kaul also explains how the RBI creating money to support the government’s borrowing needs (for capex and other spending priorities) is creating additional money in the financial system, which usually drives deposits too, but in this case, that additional money is not adding to any bank deposit growth. It’s simply more money in the system that hasn’t gone on to create demand but has met the supply-side needs (since the printed/borrowed money actually spent isn’t creating real demand for households or being processed as ‘cash sent to beneficiaries for use’).

So, yes, deposit growth is linked to systemic lending growth (not the other way around), which includes loans and investments in bonds too. But, despite loans growing at 15-16 percent YoY, the investment book is lagging, resulting in overall asset growth and deposit growth hovering around 10-11 percent YoY. 

Currently, the high LDR (elevated loan-to-deposit ratio) reflects sectoral or micro-imbalances rather than macro-imbalances. Large corporates are borrowing less, while households, MSMEs, and the agricultural sector are borrowing more but generating weak demand. 

Furthermore, if viewed from a bird’s eye macro-lens, firms, due to a compressed demand position and slowing consumption expenditure, are sitting on credit and cash without substantially investing in building ‘new capacity’ or inventories (a point this author has repeatedly argued).   

My sense is that since credit (despite its high demand) is being used, not to actually ‘invest’ (create something new or add to productivity) but rather finance borrowings or existing debt (from households to firms to government level), additional troubles will mount for India’s macroeconomic position in the near future.

Credit cycles will become weaker over time, as there is only a certain amount of space till which the RBI will borrow and finance in the absence of sufficient savings and investments coming in, and that will subsequently affect overall growth too (which is already at a precarious situation).  

There is a strong need to inter-sectionally study and understand the deposit-credit growth gap in the context of other macroeconomic vulnerabilities, which need the underlying market conditions and designs to be structurally altered and not merely tinkered with. 

Unfortunately, an intellectually bankrupt policy ecosystem, consisting of sycophants advising the current government, whose presence prevents any critical or reform-centred advice, is leading to counterproductive economic scenarios.  

The government’s inaction (and for me, what’s worse is the inability to understand the structural tenets of the current crisis and its financial implications) will cost the nation its financial health and economic robustness, ultimately driving it down to its own peril.  

(Deepanshu Mohan is a Professor of Economics, Dean, IDEAS, Office of Inter-Disciplinary Studies, and Director of Centre for New Economics Studies (CNES), OP Jindal Global University. He is a Visiting Professor at the London School of Economics, and a 2024 Fall Academic Visitor to the Faculty of Asian and Middle Eastern Studies, University of Oxford. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)