During January to May 2020, aggregate deposits in the banking system grew by Rs 7.05 trillion compared to Rs 4.65 trillion in the same period last year.

The sudden surge in bank deposits is due to a rise in overall borrowings of both the Central and state governments, rather than increased savings, according to a research report by India Ratings and Research (Ind-Ra).

While deposit accretion has been strong, a shift in the profile of the banks accruing them is noticed with depositors focusing on quality and safety to differentiate between banks. AAA rated banks in Ind-Ra’s coverage have witnessed an increase in the deposit accretion rate, both on qoq and yoy bases in 4QFY20, whereas new-age private banks, regional banks and small finance banks (SFBs) have mostly slowed down. This has created a divide in the banking segment deposit rates.

“Though almost all banks have reduced their deposits rates, the slide is much sharper in the public sector and large private sector banks, creating a wider spread between the top banks and others. The deposit rate differential is also reflected in the large spread in MCLRs of these banks; this should help in acquiring better credits while protecting their margins once credit demand picks up. Lesser flexibility in terms of attracting deposits at lower rates implies that small and low rated banks will either face the challenge of sacrificing margins to compete with large banks or have to on-board low rated customers which will increase their risk profile,” says Soumyajit Niyogi, Associate Director, India Ratings.

Credit-Deposit Disconnection

During January to May 2020, aggregate deposits in the banking system grew by Rs 7.05 trillion compared to Rs 4.65 trillion in the same period last year. The credit growth however, as expected, remained muted. The banking system’s credit grew by only Rs 2.2 trillion during January to May 2020 as against Rs 2.84 trillion during January to May 2019.

Rise in Cash in Circulation

The puzzling fact is that the deposit growth has been robust in spite of a massive rise in cash in circulation, which is leakage in the deposit base. Pursuant to the nationwide lockdown which stalled most of the economic activities, cash in circulation has risen strongly by around Rs 3.5 trillion during the first five months of 2020, highest in the last two decades (barring remonetisation period in 2017). Ind-Ra believes this has mostly been caused by two factors: 1) precautionary holding of cash and 2) government disbursements being at the bottom of the pyramid. The former is explained by the uncertainty owing to the COVID-19 breakout and prolonged lockdown. Individuals hoarded cash to avoid any risk of disruptions in the normal banking activities, a usual behaviour. Followed by the precautionary cash holding, government spending through various relief schemes has further flown to the bottom of the pyramid.

Deposit Growth Not Driven by Savings?

As against the common myth, Ind-Ra believes that this growth in deposits has not been on account of a surge in savings. Not only the lockdown has caused a significant decline in overall purchases, it has also eroded the income and wealth of producers and sellers; therefore, there is almost not much impact on aggregate savings. Moreover, even in the normal course, spending happens through the transfer of money between various modes in the banking system, without affecting aggregate deposits (barring a portion of sustained cash-based transactions). Therefore, spending in an economy (other than imports and cash transactions) has almost zero-sum impact on its aggregate banking deposit.