The State Bank of India’s economic research team warned that the race for deposits could drag on, creating a paradox in which deposit rates rise even as interest rate cuts begin.
This is because bank deposit income is taxable and its treatment (bank deposits are taxed on accruals whereas competing asset classes are taxed on redemption) is completely uneven compared to other asset classes.
“This can severely hinder (monetary) policy transmission. The Reserve Bank of India needs to innovate in liquidity management. It is time to make CRR (cash reserve ratio) a counter-cyclical policy tool,” said Sowmya Kanti Ghosh, group chief economic advisor at SBI.
He noted that asymmetric transmission (of policy rate changes) takes centre stage as Indian corporate borrowing has declined, resulting in a decline in WALR (weighted average lending rate) while weighted average deposit rates have been gradually increasing.
Ghosh stressed that downward rigidity in deposit rates will open a Pandora’s box in the Reserve Bank of India’s interest rate easing cycle.
SBI’s economic research team has observed that fixed deposits are also showing a shift towards shorter term (up to three years) as the advent of wallets, apps, IMB (internet and mobile banking) and UPI have made CASA (current and savings account) deposits more volatile. Even as banks have hiked deposit rates substantially, the returns have not kept pace with the returns on other risky asset classes.
In its latest monthly bulletin, RBI officials noted that the share of low-cost CASA deposits has almost bottomed out at around 39-40 per cent (of domestic deposits), declining steadily from around 44 per cent in 2021-22.
“This is likely to pressure banks’ net profit margins going forward and prompt them to reprice their deposit books. In fact, banks are being pressured to mobilise more funds through certificates of deposit (CDs) in June ahead of the quarter-end,” the official said.
SBI’s Ghosh warned that given the unfavourable tax treatment and application, it could adversely affect banks’ efforts to pass on lower lending rates uniformly to all borrower groups when the central bank implements future interest rate cuts.
“Deposit rates are likely to remain elevated, posing challenges to banks’ ability to prudently manage ALM (asset liability management) and maintain optimal profitability, especially given the significant capital requirements to fund economic growth and climate-related transition. These transitions will require significant milestone-based investments, some of which may need to be front-loaded to counter a carbon tax,” he said.
As of July 12, 2024, deposit growth rates of all scheduled banks (11% YoY) were lower than credit growth rates (about 14% YoY), according to RBI data.
