Why Banks Need to Look Beyond Traditional Deposits to Bridge the Credit Gap

The financial landscape is evolving rapidly, with a clear shift in how individuals manage their savings and investments. The genie is out of the bottle: capital markets and alternative investment avenues such as mutual funds have captivated the public’s imagination, offering returns that outpace traditional savings accounts and fixed deposits. This trend, underscored by the Reserve Bank of India’s (RBI) latest data, reveals that deposit growth in banks has decelerated to 11.8% as of March 2024, a drop from 13.6% in the previous year, while the asset base of mutual funds surged by 35.5% during FY2023-24. 

 Systematic investment plans (SIPs) have emerged as a household mantra, contributing nearly 20% to the total assets under management (AUM) of the domestic mutual fund industry. India's youthful population is embracing risk and growth, with capital markets attracting younger investors—the median age of participants is 32, and 40% are under 30. Conversely, older generations, especially senior citizens, continue to seek the safety of bank deposits, with 47% of term deposits held by them. 

Correcting the Imbalance 

This significant shift in savings behaviour is creating systemic pressure on India’s banking sector. The credit-deposit ratio (CDR), which reached 80% in March 2024—the highest since 2005—indicates that banks are lending more aggressively than they are accumulating deposits. In some private sector banks, the CDR has soared to 100%, raising concerns about the sustainability of current lending levels. Economic growth hinges on the ability of banks to lend, but this requires a stable and robust deposit base. Both finance minister Nirmala Sitharaman and RBI governor Shaktikanta Das have called for banks to correct this imbalance. 

Addressing this structural challenge requires a multi-pronged approach and strategic interventions that could help strengthen the liquidity of banks while maintaining their ability to lend. 

Harnessing Different Sources 

India’s pension and insurance sectors represent vast pools of untapped capital. The Pension Fund Regulatory and Development Authority (PFRDA) oversees assets exceeding ₹11 lakh crore, while life insurers manage over ₹55 lakh crore. Currently, these funds are largely restricted to government securities and AAA-rated bonds. A structured relaxation of investment guidelines, allowing pension and insurance funds to invest in bank-linked instruments under rigorous risk mitigation frameworks, could unlock significant liquidity.  

Non-resident Indian (NRI) deposits and external commercial borrowings (ECBs) present significant untapped potential for banks seeking to diversify their funding sources. However, stringent regulatory constraints, particularly around the end-use of ECBs, limit their effectiveness. By revisiting these restrictions, especially under the Foreign Exchange Management Act (FEMA), and expanding permissible uses, banks can tap into a broader range of foreign capital. Simplifying compliance processes for NRI deposits would further enhance inflows. 

In an increasingly competitive and deregulated market, banks have the flexibility to offer more attractive interest rates on fixed deposits. Some institutions have already raised their rates above 9%, drawing substantial inflows. To further incentivise deposits, the Reserve Bank of India (RBI) should enable more dynamic, market-driven rate-setting, allowing banks to compete aggressively for deposits. Transparency and fair play in rate adjustments would reassure depositors while enhancing banks' ability to raise funds, particularly from senior citizens and risk-averse individuals. 

Bank deposits, which are traditionally perceived as safer investments, lag behind market-led instruments in terms of tax incentives. Offering tax benefits on long-term fixed deposits similar to those available for equity-linked savings schemes and mutual funds could help restore balance. Such a move would particularly benefit senior citizens, who tend to shy away from market volatility but are highly responsive to tax-efficient saving vehicles. 

Tweaking Regulations 

The government’s SNA-Sparsh initiative has led to a substantial portion of government funds being retained within the RBI, limiting commercial banks' operational liquidity. Redirecting a greater share of these funds to commercial banks could significantly increase their low-cost CASA (current account savings account) deposits. This would reduce the need for banks to rely on costlier forms of borrowing, improve their net interest margins and enable greater lending flexibility. 

Housing finance companies (HFCs) are a critical player in India's affordable housing ecosystem, yet they face unique challenges related to asset-liability mismatches due to the long-term nature of home loans. HFCs, often regulated similarly to non-banking financial companies (NBFCs), require a differentiated regulatory framework that addresses their specific needs. Introducing long-term bond issuance mechanisms tailored to the housing sector and relaxing exposure limits on mutual funds investing in HFCs could help close the credit gap, enabling more sustainable growth in the affordable housing segment. 

The complexities of the financial system demand coordinated, high-level interventions. Establishing a government task force composed of senior representatives from the RBI, PFRDA, Insurance Regulatory and Development Authority (IRDAI) and other key financial regulators would provide a platform to address systemic challenges holistically. This task force could spearhead initiatives aimed at easing liquidity pressures while ensuring robust credit growth. 

Only through a 360-degree strategy can we ensure that India’s banking sector remains a pillar of strength, capable of fuelling the nation’s ambitions, while being aligned with the needs of a fast-evolving economy.  

The author is managing director and chief executive officer, Grihum Housing Finance. Views expressed are personal.