As savers turn investors, banks face dwindling CASA ratio: Is this the new reality?

Similarly, Noida-based Ashish Kumar, a 24-year-old software engineer, began a systematic investment plan (SIP) in a large-cap equity fund soon after he started working. Given the challenges the IT sector has faced in recent times, he has put his money into liquid funds—which may yield returns of up to 7%—for contingency needs. With average returns of 25% in the past year, he has decided to forego keeping money in a savings account.

Like Sharma and Kumar, many are abandoning savings accounts in favour of investing. Instead of letting their money sit idle, they’re opting to invest in FDs and liquid funds, or taking the plunge into equities, which have yielded much higher returns in recent years. India, once a country of savers, has transformed to one of investors, and the change has been “phenomenal,” Uday Kotak, Founder & Director of Kotak Mahindra Bank, told BT recently.

This shift has had a ripple effect in the banking industry. With more money moving out of savings accounts, the CASA (current account and savings account) ratios of banks have taken a hit. Of the total outstanding deposits (Rs 212.53 lakh crore) of scheduled commercial banks as of March 31, 2024, term deposits accounted for 59% (Rs 125.44 lakh crore), with the remaining 41% being CASA deposits. The FY24 figure is much lower than the 43.5% in FY23 or 45.2% in FY22.

A declining CASA ratio is worrisome for the industry, as it is an important indicator for assessing the financial health and performance of a bank. It represents the proportion of a bank’s deposits that are in current and savings accounts compared to its total deposits, and it reflects the bank’s ability to attract low-cost funding. A lower CASA ratio means banks have to pay more to get funds to lend, which increases overall costs and hence impacts profitability.

For instance, if a bank offers interest of 3% for Rs 100 in a savings account but lends Rs 100 at an interest of 7%, it stands to gain because of the higher income from the interest levied on the loan versus the interest amount it has to pay the depositor. Do note that banks don’t pay interest on current account balances.

For the Top 5 banks in terms of market capitalisation, the average CASA ratio has declined from 49.41% in FY22 to 41.74% in FY24 (see chart). Let’s delve deeper into the reasons for this fall.

Anatomy of the Fall

Several factors have contributed to the decline in CASA ratio. One reason is the high interest rates in recent years. Since May 2022, the Reserve Bank of India has increased the repo rate—the rate at which RBI lends money to commercial banks—by 225 basis points (bps) to combat high inflation. As the repo rate rose, banks also raised deposit rates to attract more deposits, limiting liquidity in the system to control inflation and meet the growing credit demand.

“One of the biggest causes for this decline is the upward interest rate regime. When we see an upward interest rate regime, people tend to move their money from CASA accounts to term deposits, because the arbitrage between the savings account and the term deposit increases,” says Sarvjit Samra, MD & CEO of Capital Small Finance Bank. The bank’s CASA fell from 41% in FY23 to 38.3% in FY24. It offers 3.5% interest on savings bank deposits.

Money shifting from savings accounts to other investment avenues—such as liquid funds—is another reason for the decline. Many prefer liquid funds to savings and current accounts due to better returns (around 7%) and quicker turnaround times of T+1 day (T: trading day). Not surprisingly, liquid funds received a monthly inflow of Rs 25,873 crore in May 2024, and their net assets under management surged 12.4% year-on-year to Rs 4.98 lakh crore, per data from the Association of Mutual Funds of India.

But who is making this shift? “Wealthier individuals with knowledge of mutual funds (MFs) were the first to move their money. They moved out their money from their savings accounts and invested in liquid funds/MFs, causing the initial drop in CASA ratios,” says Virat Diwanji, Head of Consumer Bank at Kotak Mahindra Bank.

Then, people who are risk-averse but seek higher returns than savings invested in term deposits. State Bank of India, the country’s largest bank by assets, currently offers 5.1% returns on 1-year-, 6.75% on 2-year-, and 6.5% on 5-year term deposits—much higher than the returns it offers on its savings accounts. Another reason is rising spending. “People are spending more and saving less. Other reasons like auto sweep facility offered by banks and increase in bulk deposit have resulted in low CASA ratio,” says Madan Sabnavis, Chief Economist at Bank of Baroda. The shift has increased the pressure on banks’ cost structures, squeezing their net interest margins in FY24.

Margin Pressure

The Nifty Bank index returned 18% YoY compared to the 25% offered by the Nifty 50 index as of June 21, 2024. The pressure on banks’ net interest margins (NIM) has been one reason for the banking index’s slower performance. NIM—the difference between interest income and interest paid to lenders—is a crucial indicator of a bank’s profitability. As banks’ cost of funds rises due to lower CASA ratios, NIM shrinks, signalling reduced profitability.

In Q4FY24, despite healthy loan growth increasing banks’ net interest income by 10.2% YoY, their NIMs fell 16 bps, according to a CareEdge Ratings report. “As deposit rates increase, term deposits have seen stronger growth compared to CASA, impacting the cost of funds and subsequently affecting NIM,” the report says. Over the past year, banks’ outstanding term deposits grew 18.5%, against 5.7% growth in savings.

Several other factors also contribute to the decline in banks’ NIMs. In a rising interest rate environment, deposits are re-priced more quickly, whereas changes in floating-rate loans occur at their reset periods. These adjustments do not affect fixed-rate loans. This lag between deposit repricing and loan reset has an impact on bank margins. “The impact on the loan book occurs at the reset period for floating-rate loans, while fixed-rate loans remain unchanged. As a result, the industry experienced a margin contraction last year,” explains Samra. “With most of the lending rate revisions taking place in H2 of FY24, the impact of these will be reflected in FY25. And deposit rates have more or less peaked. Thus, we believe there is a strong case for improvement in our NIM in the current fiscal,” he adds.

Saving the Day

The shrinking CASA ratio has forced banks to adopt innovative measures to lower funding costs. For instance, Kotak Mahindra Bank launched Kotak ActivMoney, which offers FD-like interest rates up to 7% per year while allowing customers to access their funds anytime. With ActivMoney, surplus funds above a threshold get automatically transferred into an FD, enabling users to earn higher savings interest, while helping the bank retain its customers and save costs.

To increase its CASA ratio, SBI started advertising about its savings accounts during the recent ICC Men’s T20 World Cup, marking the first such campaign in many years.

Banks are also exploring alternative sources of funding if CASA continues to decline. “Banks can issue certificates of deposit (CDs),” Diwanji says. “There are norms and limits to how much they can issue, but they are issued at higher interest rates to meet liquidity needs. While this may not help reduce costs since AAA-rated CDs are priced slightly higher than sovereign money rates, it at least provides liquidity,” he adds.

However, banks aren’t overly concerned about low CASA right now due to high loan demand. As long as they can get funds, they can keep lending and generate revenue. Banks are also utilising technology to streamline operations and reduce costs to maintain profit margins.

During the fortnight ending March 22, 2024, banks’ deposits grew 13.5% YoY while lending surged 20.2%, per CareEdge. With banks’ deposit growth lagging their credit growth, the credit-deposit ratio, which indicates how much money banks are lending compared to their deposits, is at its highest in 10 years, hovering around 80%.

What Lies Ahead

With RBI expected to lower the repo rate, the rest of 2024 could be favourable for banks that are struggling with falling CASA ratios. “The RBI may consider rate cuts from October 2024 after reviewing factors such as ongoing inflationary pressures, the global growth-inflation dynamic, and the policy rate environment,” says Dhawal Dalal, CIO-Fixed Income at Edelweiss MF.

But BNP Paribas cautions against misinterpreting the potential cuts as a sign of immediate relief for bank margins, since repo-linked mortgages and most prime corporate loans re-price almost immediately. However, it will set “the ground for benign margin expansion by easing the cost of funds and accelerating high-yield fixed-rate loan disbursements. The cost of funds benefit will be gradual and will come from FD re-pricing and increased CASA momentum,” it says.

This year’s monsoon will also play a major role. With many factors at play, the timing of the first rate cut is uncertain. As people get used to high returns from other asset classes such as MFs and equities, experts doubt if CASA ratios will return to their earlier levels. “Historically, when a declining interest rate regime starts, more money tends to stay in current and savings accounts. Whether this will happen again is something we have to wait and watch,” says Diwanji. “The CASA ratio will certainly improve a bit, but returning to original levels is doubtful.”

On the other hand, Bank of Baroda’s Sabnavis expects CASA to remain the same. “A drop in interest rates won’t likely affect the CASA ratio. The rate cut needs to be accompanied by a decline in competition for deposits,” he says.

While analysts have differing views on the impact of rate cuts on the CASA ratio, all eyes are on RBI’s policy action in October.

@teena_kaushal