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If current trends of slowing credit growth and robust deposit growth continue, credit and deposit growth are likely to converge by the end of FY25, according to an analysis.
Bank credit growth has moderated significantly in recent months, slowing to 14.1% year-on-year as of October 4, from around 16.0-16.5% at the end of March 2024. Meanwhile, aggregate deposit growth has eased slightly to 12.2%, down from 13% earlier. Despite credit growth continuing to outpace deposits, the gap between the two has narrowed considerably. The credit-deposit growth gap now stands at 1.8 percentage points, down from over 3 percentage points in March, signaling a shift in the dynamics of the banking sector.
“We believe the moderation in credit growth reflects the impact of tighter macroprudential policies and higher interest rates, while the decision by banks to raise fixed deposit rates over the past few quarters to bridge the credit-deposit gap is helping support higher deposits. If current credit gap trends continue and the deposit gap remains at current levels, momentum measures suggest year-on-year credit and deposit growth should converge by the end of FY25,” according to a Nomura note.
The ongoing narrowing of the credit-deposit growth gap is expected to ease some of the liquidity pressures banks have been facing in recent months. As credit growth slows and deposits continue to rise, banks may find themselves with excess liquidity, which could be channeled into government securities, thereby increasing their investment in safer assets, it said.
Changing momentum
While year-on-year growth figures show that credit is still expanding faster than deposits, an analysis of the underlying momentum reveals a different trend. According to Nomura, the incremental rise in bank credit for FY25 to date has been slower than the historical norm. Bank credit has grown by just 5.2% from April 1 to October 4, compared to the typical run rate of 7.7% during similar periods in prior fiscal years, such as FY23 and FY19. These years were selected as benchmarks, avoiding distortion from merger effects (FY24), the pandemic (FY21-FY22), and the shadow banking crisis (FY20).
On the other hand, aggregate deposits have risen by 6.9% in the same period, outpacing the usual growth rate of 5.4%. This creates a distinct divergence between the trends for credit and deposits, with a credit gap of -2.5 percentage points (FY25 growth minus the normal run rate) and a deposit gap of 1.5 percentage points.
Macroprudential policies and rising rates
Nomura attributes the moderation in credit growth to the tightening of macroprudential policies and the rising interest rate environment. As the Reserve Bank of India (RBI) continues to prioritize inflation control and financial stability, higher borrowing costs are slowing down demand for credit, especially in the corporate and retail segments. Additionally, banks have been more cautious in their lending practices, particularly in riskier segments like unsecured loans.
Simultaneously, banks have been actively raising fixed deposit rates over the past few quarters to bridge the credit-deposit gap, which has supported stronger deposit inflows. With higher deposit rates, customers are more inclined to park their funds with banks, improving liquidity in the banking system.
The report also highlights that this convergence would help alleviate one of the structural challenges in the banking system—managing liquidity amid a widening credit-deposit gap. A balanced growth trajectory for both credit and deposits would allow banks to better manage their capital and mitigate risks associated with volatile credit expansion.
Outlook for the banking sector
Looking ahead, the report underscores the importance of continued vigilance in monitoring credit growth, particularly in the context of macroeconomic factors like inflation, interest rates, and regulatory tightening. The moderation in credit expansion is expected to persist as long as macroprudential policies remain stringent and the cost of funds stays elevated. However, the rise in deposits is expected to continue, driven by attractive fixed deposit rates and the ongoing efforts of banks to shore up their deposit base.
It concludes that the banking sector is likely to experience more balanced growth in the coming quarters, with a gradual convergence between credit and deposit growth by the end of FY25. This could enhance overall liquidity in the system and provide banks with more flexibility to invest in government securities, while maintaining a cautious approach to lending.
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