Asymmetric Deposit Accretion Creating Challenges for Small and Low-Rated Banks: Ind-Ra
There is sudden surge in bank deposits due to a rise in overall borrowings of both the central and state governments, rather than increased savings. While deposit accretion has been strong, a shift in the profile of the banks accruing them is noticed with depositors focusing on quality and safety to differentiate between banks, says India Ratings and Research (Ind-Ra).
In a research note, the ratings agency says, "AAA rated banks in Ind-Ra’s coverage have witnessed an increase in the deposit accretion rate, both on quarter-on-quarter (qoq) and year-on-year (yoy) bases in fourth quarter (4Q) of FY20, whereas new-age private banks, regional banks and small finance banks (SFBs) have mostly slowed down. This has created a divide in the banking segment deposit rates."
Though almost all banks have reduced their deposits rates, according to Ind-Ra, the slide is much sharper in the public sector and large private sector banks, creating a wider spread between the top banks and others.
"The deposit rate differential is also reflected in the large spread in marginal cost of funds-based lending rates (MCLRs) of these banks; this should help in acquiring better credits while protecting their margins once credit demand picks up. Lesser flexibility in terms of attracting deposits at lower rates implies that small and low rated banks will either face the challenge of sacrificing margins to compete with large banks or have to on-board low rated customers which will increase their risk profile," it says.
During January to May 2020, aggregate deposits in the banking system grew by Rs7.05 trillion compared to Rs4.65 trillion to the same period last year. The credit growth however, as expected, remained muted. The banking system’s credit grew by only Rs2.2 trillion during January to May 2020 as against Rs2.84 trillion during January to May 2019.
According to Ind-Ra, the puzzling fact is that the deposit growth has been robust in spite of a massive rise in cash in circulation, which is leakage in the deposit base. It says, "Pursuant to the nationwide lockdown which stalled most of the economic activities, cash in circulation has risen strongly by around Rs3.5 trillion during the first five months of 2020, highest in the last two decades (barring remonetisation period in 2017)."
Ind-Ra says it believes this has mostly been caused by two factors, first precautionary holding of cash and second government disbursements being at the bottom of the pyramid.
"The former is explained by the uncertainty owing to the COVID-19 breakout and prolonged lockdown. Individuals hoarded cash to avoid any risk of disruptions in the normal banking activities, a usual behaviour. Followed by the precautionary cash holding, government spending through various relief schemes has further flown to the bottom of the pyramid," it added.
As against the common myth, Ind-Ra says it believes that this growth in deposits has not been on account of a surge in savings. It says, "Not only the lockdown has caused a significant decline in overall purchases, it has also eroded the income and wealth of producers and sellers; therefore, there is almost not much impact on aggregate savings.
Moreover, even in the normal course, spending happens through the transfer of money between various modes in the banking system, without affecting aggregate deposits (barring a portion of sustained cash-based transactions). Therefore, spending in an economy (other than imports and cash transactions) has almost zero-sum impact on its aggregate banking deposit."
The ratings agency says it believes that the deposit growth has been on account of a process known as endogenous money creation, where incremental credit creates fresh deposits in the banking system.
During January to May 2020, incremental credit in banking system remained tepid, but the centre and various states borrowed significantly.
"It was also observed that the support from the RBI to the central and state governments has increased substantially through ways and means advances to address short-term funding gap for the respective governments, along with open market operations to ensure the system liquidity is at ease. While there has given a fillip to reserve money, muted bank credit has reduced broad money creation, leading to a lower multiplier," Ind-Ra says.
While there is a high system-level deposit growth, for individual banks it is asymmetric growth, the ratings agency says.
As per Ind-Ra, the five key defining factors for deposit accruals in the Indian banking system are franchise; geographical spread (like branches); rate of interest offered; and impact of technology and customer segmentation and service orientation.
Traditionally, banks competed on franchise, geographical spread and customer service levels for accrual of deposits, however with the emergence of new-age private banks and SFBs, factors such as rate of interest offered, technology and digital offering and customer service have gained importance.
"Banks with large operations, strong retail and granular current and savings account profile would continue to gain deposits in the near term at the cost of other private banks as the redistribution of deposits could continue," the ratings agency says.
While the sources of deposit creation have seen a change, Ind-Ra feels even the profile of banks that are accruing these deposits is undergoing a change rapidly. It says, "This is clearly visible in terms of flight to quality and safety, with AAA rated banks witnessing increased deposit accretion rates, both on qoq and yoy bases. We expect this to continue in the near term with new-age private banks, regional banks and SFBs mostly slowing down, as safety has come at the forefront after the events that played out with PMC Bank and thereafter Yes Bank".
Over the medium to longer term, the ratings agency feels, while new-age private banks, regional banks and SFBs could regain their momentum partly, the dominance of banks with strong franchise and large geographical spread would continue, given the higher safety (read mental peace) that they offer to their deposit customers.
Ind-Ra says its interactions with a few SFBs suggest that while they were facing challenges in March 2020, the pressures have eased in April and May and they are able to accrue deposits once again amid reduced deposit rates.
According to the ratings agency, large banks – both public and private are both well capitalised and sitting on surplus liquidity amid the muted credit offtake environment and it believes that this will lead to competition for credit offtake once it returns in the system.
"Large banks will be able to attract better rated customers by taking advantage of their lower cost of funds, driven partially by their lower cost of deposits. Thus, in the agency’s opinion, the overall risk profile of small-sized and low-rated banks from an asset quality perspective will become vulnerable as they have to sacrifice margins to compete with large banks for the same accounts or will have to on-board low-rated customers," Ind-Ra concludes.