Deposits won’t grow faster; it is time for credit growth to slow down

We have been so caught up reading the lips of the monetary authorities that we have not paid enough attention to the import of their actions. All of the RBI’s liquidity actions in recent months have been consistent with the monetary policy stance. Thus, for example, the central bank drained excess liquidity from the banking system in June when government spending had picked up after the general election and there were foreign fund inflows after Indian bonds were included in the JP Morgan index. Similarly in December 2023 and May 2024, when government surpluses with the central bank had spiked above ₹4 trillion, the RBI conducted repo auctions to inject system liquidity.

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Irrespective of external flows or government spending, deposit accretion levels are largely a consequence of the monetary policy stance and resultant liquidity actions. What is in banks’ control, however, is the composition of deposits between Casa (current account and savings account) deposits, retail term deposits and bulk deposits. This mix is largely driven by the prevalent interest rates in the system, and as deposit rates have spiked, retail term and bulk deposits have seen their share increase with Casa growth being anaemic.

But as banks went out on a limb to raise deposits with multiple schemes, the goal posts shifted again. To minimize individual bank liquidity risk and maintain healthy balance sheets, the regulator advised caution on the reliance on bulk deposits to bolster deposit growth. It has also mooted a new liquidity coverage ratio framework which will force banks to raise more granular deposits.

Looking at the monetary stance and the regulator’s liquidity actions, one needs to be reconciled with deposit growth continuing around current levels, irrespective of what officials say. It also shows that there is only one way the system is headed—credit growth needs to slow down in line with the deposit growth calibrated by RBI.

When it comes to credit, regulatory actions have been a lot more emphatic. Over the last 18 months, the RBI has been vocal about credit excesses in specific segments and products such as gold loans and loans against shares wherein cease-and-desist orders have been issued to specific non-banking financial companies (NBFCs). It acted forcefully by increasing risk weights for certain products such as unsecured personal loans and credit cards as also for certain segments of borrowers such as NBFCs.

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Thus, there is no doubt that this is the best path forward from a financial stability and systemic risk perspective. And it is important for all stakeholders to clearly see the writing on the wall.

What would be optimal credit growth for the system for fiscal year 2025 (FY25)? Assuming deposit growth remains steady at close to 12% while incremental loan to deposit ratio eases to 85% from around 95% last year, credit growth would likely slip to close to 12.5-13% in FY25 from 16% last year.

The widening wedge in the credit-deposit ratio will likely see convergence over the coming year as this plays out. This trend is also in alignment with the analysis in the RBI Financial Stability report on credit-deposit divergence during growth cycles which usually lasts for two-four years. The slowing credit growth will also serve as a good reality check on the quality of credit originated during the easy money times post covid.

Srinivasan Varadarajan and Kanika Pasricha are, respectively, chairman and chief economic adviser at Union Bank of India.

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