Lending rates have risen in response to the RBI raising policy rates. Now, as credit offtake continues to rise and as RBI has reduced the surplus liquidity in the system, the commercial banks find it necessary to raise deposit rates to attract savings. Banks started hiking lending rates after the RBI raised policy repo rate in May for the first time in more than two years. Increase in deposits rates failed to match this hike. But this is set to change. The combined impact of a reduction in surplus liquidity and rise in demand for credit is expected to reflect in an uptick in bank deposit rates.
This is already becoming evident. Deposit rate, at the lower end of the range for term deposits of more than one year, went up by 30 bps to 5.3 per cent in the week ended July 29. It had remained unchanged at 5 per cent since January. The upper end of the range had increased by 15 bps by end-May to 5.75 per cent. It has, since then, remained unchanged.
Deposit rates are rising at a slower pace compared to lending rates. The weighted average domestic term deposit rate (WADTDR) of scheduled commercial banks (SCBs) had dropped from a peak of 6.91 per cent in January 2019 to 5.02 per cent by February 2022. Then, it increased by a mere 11 bps to 5.13 per cent by June. In contrast, the magnitude of increase in lending rates has been higher. Weighted average lending rate (WALR) on outstanding rupee loans of SCBs had dropped to a low of 8.72 per cent in April 2022. Then it increased by 21 bps to 8.93 per cent by end-June 2022. In case of fresh rupee loans, the magnitude of the interest rate hike was more. WALR on fresh rupee loans increased by 42 bps to 7.94 per cent between April and June.
Surplus liquidity in the system had remained quite high till May because of which banks did not feel the need to attract more deposits by raising interest rates. Surplus liquidity as measured by daily absorption through variable rate reverse repo (VRRR) and standing deposit facility (SDF) averaged at Rs.6.7 trillion during April-May. But it dropped to 4.2 trillion in June and further to Rs.3 trillion in July.
The RBI had announced a policy of withdrawal of accommodation beginning from its first monetary policy announcement for 2022-23 on April 8. This is the principal reason for the shrinking of the liquidity surplus. In addition, a reversal of capital flows are also likely to have contributed to the shrinking of the liquidity surplus.
The RBI, in its third monetary policy statement on August 5, has stated a continuation of this policy of withdrawal of accommodation. This will lead to a further fall in surplus liquidity. Consequently, banks will need to hike rates to attract more deposits.
At a time when excess liquidity is getting drained out from the system, demand for bank credit is also witnessing a steady pick-up. This is mainly in the retail loan space and from the services sector. Outstanding bank credit increased in April over the preceding month for most sectors. This was quite unusual, as April usually sees a decline after the sharp spike in credit offtake in March in an end-of-the-year rush to achieve fiscal year targets. Credit disbursements slowed in May but recovered sharply in June. Overall disbursements of non-food bank credit, at Rs.2.7 trillion during the April-June 2022 quarter was second highest when compared to past first quarter disbursements.
Looking ahead, the onset of the festive season is expected to boost demand for bank credit. Manufacturers of consumer durables had postponed production in view of high inflation leading to a fall in discretionary spending. However, in view of the upcoming festival season, sentiment amongst manufacturers is reportedly upbeat regarding demand recovering to pre-Covid levels in the automobiles, consumer electronics, FMCG and retail sectors. Credit offtake for personal loans and services such as consumer durables, vehicle loans and retail trade may therefore be expected to pick-up. Demand for housing loans is good considering the strong offtake in the first quarter of 2022-23 fiscal year.
Capacity utilisation has picked-up in the March quarter. As per the Order Book, Inventories and Capacity Utilisation Survey (OBICUS) conducted by RBI, capacity utilisation went up to 75.3 per cent in the March quarter. This was the highest since March 2019. This could lead to more investment spending by corporates. As a result, investment demand for bank credit could improve as well.
If the pick-up in credit disbursals gathers pace in the coming months, then the expected fall in liquidity will prompt banks to hike deposit rates in order to attract more deposits. There are signs that banks will be forced to move in this direction.
Credit-deposit (CD) ratio, in outstanding as well as incremental terms, has been rising. This points to credit growth outpacing the increase in deposits. Outstanding credit to deposit ratio recovered to 72.7 per cent by end-May 2022. By July 15, it had gone up to 73.1 per cent. The ratio had hit a low of 70 per cent in October 2021. The ratio needs to improve further, as it is still away from the high of 78.1 per cent recorded in February 2019.
Incremental credit deposit ratio has been nearing or rising above 100 per cent from the week-ended May 20. This implies that credit disbursements have been exceeding deposit mobilisation from June.
Some housing finance companies (HFCs) and NBFCs increased their interest rates on fixed deposits following the repo rate hikes by RBI in May and June. Following this, these NBFCs were able to raise higher quantum of deposits. Sundaram Housing Finance reportedly raised Rs.400 million in June and Rs.600 million in July. This is a substantial rise compared to the Rs.60-70 million that the HFC had raised in May. PNB Housing Finance also reportedly witnessed a 65 per cent rise in FDs from April to June.