In the recent past we have read about:
- Credit growth has been faster than deposit growth for the banks in India leading to negative gaps of almost 700 bp over the last two years
- The CASA ratios of most banks have dipped for most banks QOQ and YOY
- RBI is concerned about the growth in unsecured lending in the system by fintechs, NBFCs and banks and hence the greater cautionary oversight
- Banks are being encouraged by RBI to moderate their CD ratio to 75% which most banks have breached, some beyond 100%.
- Since mid last year, systemic liquidity has been more or less consistently in deficit except for one or two small periods due to active RBI intervention.
- There has been an anticipation of rate cuts in the US following strong growth which is expected to lead to repo rate cuts in our country too.These expectations been deferred yet again at the last MPC, FOMC, and ECB meetings .
- While headline inflation has been trending down or has remained consistent, food and fuel inflation have been more stubborn
- We expect our GDP to grow at 7% in FY 25 and so do most of the multilateral agencies.
In the absence of any meaningful private sector investment, growth has been heavy lifted by government spending in the last few years mainly to fund infrastructure creation. Young India has also not saved much in traditional instruments, by way of bank deposits, and even here, it has been usually higher cost term instruments; Hence, the negative growth in CASA ratios of the banks. This Young India is also less fearful and more greedy and also more adventurous than their previous generations in diversifying their savings into equity, mutual funds, digital/crypto currency, and other alternate assets. The SIPs have therefore now grown to almost Rs 20000 crore each month and the aggregate mutual fund industry AUMs have crossed Rs50 lac crores.
What does this all portend for the Indian financial system specially for the banks for whom the left side of their balance sheet, the liability side, has been more important than the asset side? While banks in India have been dependent on primary deposits from customers through their branch network to finance assets, in more advanced countries, the assets are usually match funded for term and cost through greater dependence on market borrowings an there is lesser dependence on primary deposits .
Will the liquidity deficit and negative growth in deposits vis credit growth be only a temporary phenomenon and would it be corrected in the next few quarters? Every banker seriously hopes so.
What gives them this hope? Private sector investments are on the drawing board and would start sooner than later given the high utilisation of existing capacities. FPI in debt would increase multifold post inclusion in J P Morgan and Bloomberg Indices beginning this fiscal. Core inflation would be moderated within acceptable and targeted levels not requiring RBI intervention to manage liquidity so actively, who would then refocus on cost of liquidity rather than quantum. And, of course, there would be rate cuts going forward following similar FED action as expected in the USA.
This of course assumes that fuel would remain only a joker in the pack and not come out of it, we have a reasonably good monsoon and no surprises on droughts and floods beyond normal, and long awaited private sector investment, both domestic and overseas catches up, and also FPI inflows in debt come in as anticipated. These assumptions have been made factoring the looming Iran-Israel problem and the imbroglio related to amendments in Indo Mauritius tax treaty as temporary blips.
Our economy is expected to grow from USD 3.5 trillion to USD 7 trillion in the next few years. The banking subsystem which is presently only 70% of the GDP will also grow, hopefully, more than commensurately and hence more than double in the next few years. For all this to materialise, we need to have the liability side of banks reverting back to normal. Meaning, customer primary deposits would need to increase substantially and that too in the same ratio between CASA and Term deposits as hithertobefore. Otherwise the cost of fund would restrict investments and may fuel inflationary pressures and/or restrict the ability of banks to raise capital in the face of lower profitability affecting their growth.
All this with the assumption that everything would return to normal as we have seen in the past including the behaviour of the savers, Young India savers.
One of the retired Bank Chairman used to remind us quite frequently that our high CASA franchise, specially savings account balances, was primarily due to the laziness of our customers and also the avoidable cumbersome procedures at our bank branches. He was quite prescient, perhaps.
Financial literacy is going to hasten this process, going forward. Coupled with tech literacy and ease of transferring balances seamlessly across deposit products and asset classes, which no banking app offers presently (there are too many frictional hoops requiring multiple logins and logouts and OTPs etc), this may attain universal traction. We are witnessing this transition in our Young India Savers.
With 65% of our Young India being below 35 years and in an aspirational hurry to achieve and acquire more and more, there is a distinct possibility of continuance of their aversion to not being satisfied with low return investments/savings. Greed over fear.
A Structural shift in their behaviour cannot be ruled out.
Banks and GDP have a mutually beneficial dependency and if primary deposits are impacted adversely, would our banking system growth remain unimpacted? And if that be so, do banks continue to fund credit growth through short term CDs as they have done this Feb 24 (quantum of CD issuances have trebled YOY), increasing their funding costs and ALM risks? A caveat here, yes there would be a return to the normal as far as as the heightened expectations of Young India Savers are concerned, as hithertobefore, if there are major corrections in the markets, equity, alternates, mutual funds, real estate, gold etc. Fear over Greed. Hopefully, things should not come to this pass.
If we accept the hypotheses, howsoever distant, that there could indeed be a structural shift in the behaviour of depositors in this Young India, how do we meet the funding requirements for investment in our economy to ensure that we achieve our projected GDP levels in the envisaged timeframe?
This would imply that we borrow more to sustain growth. There would be limitations to this avenue too, on account of capital, increased costs, profitability, and consequent ratings. Therefore, we may have to accept the possibility of limiting the book size for both NBFCs and Banks.
The other option is to seriously examine the originate to distribute model, sell down seasoned assets, followed in more advanced economies where the growth aspirations in the financial sector tempered by profitability and capital have now been more sustainable .
Essentially, it would imply increasing the velocity of the available capital. A possible redefining of the role of banks and other intermediaries of our financial system may, also be required.
It would require a change in the mindset of banks and other intermediaries from showing YOY exponential growth in their books. It would also mean refocusing efforts and energy for optimising their return on capital and book. It would imply creating higher yielding securitisable / tradeable instruments to offer as an alternate to our Young India savers as distinct from the institutional level securitisation which we see today. Furthermore, it would require considerably enhancing the customer engagement and making it more comprehensive rather than transactional. It would also imply that the suite of products and services offered would undergo an expansion and diversification for our financial system participants. Lastly, it would also require creating the institutions and structures to facilitate aggregation, securitisation, servicing, settlement, and trading of such diversified instruments for our nextgen Young India savers.
Are we prepared for this?
The Indian Banker 