Where are the deposits? RBI’s policy transmission hits another roadblock

The Reserve Bank of India (RBI) has struggled for more than a decade trying to ensure that policy rate changes end up getting reflected in bank lending rates. Fed up with banks unwilling to play ball on lending rates, the central bank has changed the math behind loan rates thrice in the last decade. How banks calculate their loan rates could change yet again this year, if RBI goes ahead with a proposal to link them with external benchmarks.

But this time, the math is not the central bank’s only problem. The growing currency in circulation is a greater risk at present, given the implications on liquidity. The fact that it has far exceeded deposit growth makes the problem bigger. Analysts at Edelweiss Securities Ltd point out that currency in circulation as a proportion of deposits is back to pre-demonetization levels and higher than the average in the past 25 years.

Falling deposit growth and rising cash among Indians are twin blows to liquidity in the banking system. Edelweiss’s analysts expect financiers to be more aggressive in seeking deposits. In fact, they say rates may even move up, which is a risk to banks’ margins.

Deposit growth has been falling deposit growth, rising notes in circulation curb policy transmission onto lending rates in circulation rose 17.9% in Feb, up to pre-demonetization levels as a proportion of deposits of a rate cut onto loan rates requires deposit growth pickup, slower currency leakage even though real rates have risen, because of the drop in retail inflation. This is hardly surprising. Average Indians don’t sit and look for real returns. What they see is nominal deposit rates and this has fallen sharply.

The weighted average term deposit rate has dropped by 100 basis points in the last three years. Unless Indian households warm up to deposits again, banks will find it difficult to cut rates. “Transmission of policy rates will have to be accompanied by a fall in deposit rates,” said Saugata Bhattacharya, chief economist at Axis Bank Ltd. He added that the recent move of State Bank of India to link its savings rate to the repo rate could give some room to lower lending rates. But this could be a one-off since term deposits form as much as 60% of banks’ total deposits, and hence any cost benefit that finds its way to loan rates needs a cut in term deposit rates.

Meanwhile, as cash continues to flow out of banks, market rates could also remain elevated. Currency in circulation grew at a brisk 17.9% year-on-year in February. The drain on liquidity has made the central bank buy government bonds to pump in money incessantly. RBI has also added an unusual tool of forex swaps to its liquidity management arsenal lately. Currency with the public has grown at a brisk pace, tightening liquidity in the system. Ironing out cyclical wrinkles of liquidity is easy but what about the long term? Surely, RBI cannot infinitely keep buying bonds or even dollars to keep the rupees coming in. Unless deposit growth bounces Bank deposit growth has been falling consistently since 2009-10, although it has picked up of late. back or the currency leak from banks slows down, the central bank will have a tough battle to prod the lenders and the market to bring down borrowing costs should it decide to cut rates in April.

The Mint, 19th March 2019

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SC order on RBI circular: More options for banks to tackle defaulting firms

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