Indian banks are staring at worrisome savings and investment trends

As on 28 June, bank deposits had grown 11.1% year-on-year, as against credit growth of 17.4%. While acknowledging changes in Indian saving patterns, he exhorted banks to step up efforts to mobilize deposits. 

Similarly, finance minister Nirmala Sitharaman, while laying out figures for small savings mobilization in Parliament, highlighted the country’s declining rate of deposit growth.

The outlook of people and their interactions have seen significant changes in recent years. Isolation during covid went with deep digitization. Even as the digital divide has been closing, technology has made many services accessible to large numbers. These include convenient avenues for investment and credit. 

Also read: Deposit Dilemma: FM Sitharaman challenges banks to think outside the vault as credit outpaces savings growth

The spread of financial literacy, particularly through social media, has led to informed choices being made from a basket of investment options. A declining interest-rate regime occasioned by the pandemic had led to a yawning gap in the rate of return between bank savings and equity. 

The popular discovery of superior returns from non-debt instruments, especially in real terms, has marked a shift away from money being kept with banks. 

The investor today seems less willing to pay for the financial intermediation done by institutions that mobilize savings to lend borrowers. This behavioural change is causing a paradigm shift in financial markets.

Financial markets offer an institutional framework that enables trade through various instruments designed to address the needs of society at large. 

As I said in a recent lecture, the interdependence of economics, sociology, politics and technology creates fusion, and emerging economic trends often become capricious. The transformation in the behaviour of savers will have structural consequences for the business model of intermediary institutions.

In the last one, five, 15 and 20 years, the National Stock Exchange’s Nifty-50 index has delivered compounded annual returns of 28.4%, 17.6%, 11.8% and 12%, respectively. Returns on mid-cap and small-cap stocks have been higher. Some companies in sunrise industries have delivered still higher rates of return.

Even though market valuations of individual companies now appear stretched, individual investors remain bullish on the strength of the Indian economy’s high growth prospects, macroeconomic stability and improving corporate governance standards, in addition to the experience of high returns on equities and physical assets (mainly real estate). 

Retail investors have chosen to take the systematic investment plan route. The number of demat accounts has grown from 41 million in 2019-20 to 151 million, as of end 2023-24, and are growing at an average of 3.1 million per month.

Also read: Amid the worst deposit crunch in two decades, RBI urges banks to adjust to changes in how people save

Proactive regulation of capital markets and the record of scam-free stock-market booms (in contrast with large-scale market misconduct seen in 1991 and 2001) over the past two decades have strengthened these trends by instilling public confidence.

Every investor makes trade-offs to balance liquidity, returns and safety. With the operational efficiency of the equity market having been enhanced by the transition from T+1 to T+0 settlements, the ease of making transactions has improved. With market depth, equity sales and purchases are easy to execute, so liquidity is no worry.

On safety, even individual investors are learning the ropes of risk management by dabbling in the derivatives segment. Astronomical transactions in daily swaps, notwithstanding the losses made by most individual participants, can be seen as their investment in learning how to mitigate market risks.

With liquidity and safety broadly taken for granted, the focus of retail investors has turned to returns, which in the case of equities beat fixed-income securities by far. The average returns on debt instruments range from only 6% to 9%. 

Debt mutual funds are getting dismally low inflows now, and even this money is coming in mainly to meet statutory obligations to invest in debt, or as part of treasury management needs to park excess funds.

The banking industry is thus at a major crossroads. Several banks, especially in the private sector, are offering over 7% interest per annum on deposits, which ranges from 10 to 75 basis points above 10-year government-security yields. 

Yet, deposits are hard to attract. It should be no surprise that the profitability of banks is coming down. Not long ago, some lenders enjoyed a net interest margin of 4-4.5%. That’s no longer so.

The Bank Nifty index has delivered a return of 14% and 12.5% over the past one year and five years, respectively. This is much lower than what the Nifty 50, composed of a wide range of stocks, has delivered. It’s no wonder that private sector banks are no longer preferred investment options for overseas fund managers.

Treating just the symptoms by marginally increasing interest rates and/or pushing sales teams to leverage customer relationships to increase deposits will not suffice as a response. 

Also read: Need to explore tax benefits, other options to aid bank deposit growth: SBI MD

The structural transformation in the country’s patterns of saving and investment warrants a re-engineering of the organizational design and business model of banks. Similar dynamics among insurers also need a look-in. In a liberalized market, it is the fittest that survive.