Commercial banks have been slow in raising interest rates for depositors compared to their record in raising rates they charge borrowers.
Deposit rates bottomed out in February 2022 at 5.02 per cent. In seven months, by September 2022, they had risen by 36 basis points to 5.38 per cent. This is the weighted average domestic term deposit rate of scheduled commercial banks on outstanding term deposits.
The weighted average lending rate of commercial banks on outstanding rupee loans was 8.81 per cent in February 2022. It bottomed at 8.72 per cent in April. Since then it has risen to 9.23 per cent by September 2022. The increase in lending rates since February is therefore 42 basis points when the increase in deposit rates was lower, by 36 basis points. The increase in lending rates of course is much sharper at 51 basis points since April.
Commercial banks are expected to maximise profits and their decision to raise interest rates for depositors and borrowers differentially is understandable. The strategy has worked well for banks as most saw their net interest margins rise between the quarter ended March 2022 and September 2022. This in turn has helped banks grow their profits. Net profit of 41 listed commercial banks grew by 37.6 per cent y-o-y, in the June 2022 quarter. Profits grew further by a higher 57.3 per cent in the September 2022 quarter according to data from 34 listed banks.
But, net interest margins of banks may start to narrow soon for at least two reasons.
First, liquidity in the system is shrinking. Average daily surplus liquidity in the system has dropped sharply to Rs.1.4 trillion in October from Rs.7.8 trillion in April. As a result, banks have started raising rates to attract more deposits.
Second, bank deposits from the household sector have already dropped quite sharply in recent times. There seems to be a structural shift in the allocation of financial assets by the household sector in India. Bank deposits that were traditionally very popular with households are less preferred now. Bank deposits accounted for a little over 34 per cent of the total financial assets of households in 2018-19 and 2019-20. In the pandemic year of 2020-21, this increased to nearly 39 per cent. This possibly reflects some flight of capital to relative safety.
In 2021-22, the share of bank deposits in total financial assets of households dropped rather sharply to 25.5 per cent - a 13 percentage point fall from 39 per cent in 2020-21. The other two drops were in currency in hand and in life insurance. Households seem to have shed the safer avenues of financial saving. Instead, they have moved their wealth into the relatively riskier assets such as mutual funds which saw its share go up from 2 per cent in 2020-21 to 6.3 per cent in 2021-22.
There is a possible upside in the share of mutual funds in the total financial assets of households as it accounted for a higher 6.7 per cent in 2018-19. So, bank deposits may continue to face competition from mutual funds.
The other source of competition is investments into provident fund and pension funds. The share of investments into this has increased from 17.3 per cent in 2020-21 to 22.7 per cent in 2021-22. The increase in provident fund and also in small savings possibly reflects the shift in savings towards higher yields in these instruments compared to a term deposit with banks. Investments into small savings also increased from 8.9 per cent in 2020-21 to 13.3 per cent in 2021-22.
If commercial banks need to shore up their liabilities with cheaper funds to build their assets book, it perhaps, needs to respond to this structural shift away from low and sub-inflation level interest rates offered by them to household depositors.
Banks can see the effect of this shift in the composition of their deposits as well. As of March 2019, the household sector accounted for 63.2 per cent of total deposits. This had increased to 63.5 per cent as of March 2020 and then to 64.1 per cent as of March 2021. But, as of March 2022, the share of the household sector fell quite substantially to 62.6 per cent.
The weighted average domestic term deposit rate of scheduled commercial banks on outstanding term deposits at 5.4 per cent is lower than the prevailing inflation rate. Given that inflation has been close to 7 per cent, depositors face negative interest rates and see a steady fall in the purchasing power of their money in the bank. Uncertainties of the equity markets and the global financial markets in general are likely pushing households to invest into gold as a safe haven. This shows up in the sustained increase in gold imports.
Households are looking for avenues to park their savings and bank deposits are their least preferred option at the moment.