Credit-deposit ratio: A key metric for India's bankers is sending out a red signal

Banks have been facing hurdles in deposit growth as they are not keeping pace with their lending activities. 

During the fortnight ending March 22, 2024, deposits saw a 13.5% increase, reaching Rs 204.8 lakh crore compared to previous year. However, lending during the same period surged by 20.2%, reaching Rs 164.3 lakh crore, as per a report by CareEdge Rating.

With deposit growth of banks being slower than their credit growth, the credit-deposit ratio – which tells us how much money banks are lending compared to what they have in deposits – is at its highest in 10 years, hovering around 80%, a surge of 38 basis points compared to the preceding fortnight, according to CareEdge Ratings report. 

A high CD ratio indicates liquidity and credit risks for banks.

But why the slow growth in deposits? 

Well, banks are facing stiff competition not just from each other but also from mutual funds and also from physical assets such as gold and real estate market. 

Uday Kotak, Founder and Director of Kotak Mahindra Bank, told Business Today that he believes that India is transitioning from a nation of savers to investors, posing a long-term challenge for the banking sector, which relies on Current Account and Savings Account (CASA) deposits as its primary funding resource.

The good news is quarterly updates from January to March for certain banks revealed that deposit growth has been surpassing credit growth. 

For instance, HDFC Bank's sequential figures demonstrated a year-on-year deposit growth of 7.5%, in contrast to a credit growth of 1.6 %.

On the other hand, the higher credit growth continues to be primarily driven by demand for personal loans. The personal loans segment has remained the largest segment, along with NBFCs, while the industrial sector reported muted growth. 

Sensing the possibility of overheating, the RBI recently increased the risk weightage for unsecured loans, requiring higher capital allocation for both banks and NBFCs. This is expected to slow consumer lending and reduce yields, as unsecured loans typically offer higher returns than mortgages.

"While economic growth remains strong, any sustained slowdown could see a sharp spike in non-performing assets (NPAs)," Deepak Jasani, Head of Retail Research at HDFC Securities told Business Today, adding that banks need to fine-tune their credit appraisal systems to protect themselves from NPAs in the unsecured book. At the same time, banks are scaling up under-penetrated businesses that offer potential for growth, such as business loans, MSME loans, consumer durables loans, and microloans.

The report also stated that credit rise can continue to be attributed to the impact of HDFC’s merger with HDFC Bank along with the growth in personal loans. If we exclude the impact of the merger, credit grew at 16.3% y-o-y for the fortnight compared to last year’s growth of 15.0%. 

Sequentially, credit grew by 0.7%. Similarly, for deposits excluding the merger impact, growth stood at 12.9%. 

Sequentially, deposits grew by 0.3%.

During a recent meeting with banks, RBI Governor Shaktikanta Das emphasised the importance of sustained vigilance. He highlighted several critical areas, including the viability of business models, the concerning trend of excessive growth in personal loans, adherence to co-lending guidelines, and banks' exposure to NBFCs. Rajeev Yadav, MD & CEO of Fincare Small Finance Bank, which merged with AU Small Finance Bank on April 1, told Business Today that RBI's focus on continued vigilance against potential risks is particularly relevant for small finance banks due to their focus on underserved segments. 

"The surge in personal loan growth, while positive for financial inclusion, necessitates close monitoring and responsible lending practices".