‘Economic growth, income level drive bank deposits’

In the backdrop of tightening financial conditions on account of low deposit growth, a Reserve Bank of India study said accelerating the rate of economic growth and disposable income holds the key to higher deposit mobilisation by the banking system.

Outstanding deposits of scheduled commercial banks (SCBs) at ₹1,25,726 billion, as on March 31, accounted for 128.7 per cent of outstanding bank credit compared with 132.5 per cent a year ago.

This reflects the tightening of financial conditions due to low deposit growth, according to the study, Bank Deposits: Underlying Dynamics.

“Close co-movement is visible between variations in deposit growth and interest rate — a downward slide till November 2017 and upward movement thereafter. The closest co-movement is observed between deposit growth and nominal GDP growth, as evident from the increasing trend between 2003-08, and the slowdown since then,” said RBI officials Harendra Behera and Dirghau K Raut (Department of Economic and Policy Research), and Arti Sinha (Department of Statistics and Information Management) in the study.

Income drives deposits

The co-movement of deposit growth is stronger with the growth of nominal GDP than with the deposit interest rate, suggesting that income effects are more powerful than price effects in driving deposit growth.

Competitive investments

“Besides income and the interest rate, mobilisation of deposits seems to be affected by substitution effects emanating from small savings. There appears to be positive co-movement in the more recent period, suggesting reduction of interest rate differentials. In the long-term, however, both deposit growth and small saving share common downward trend,” the study said.

Incentives in the form of income tax treatment available for small saving schemes drives competition between bank deposits and small savings.

In the long run, this competition fades away in view of limits on the tax concession for small savings — particularly on the Public Provident Fund — which are revised from time to time in sync with investment limits under Section 80C of the Income Tax Act.

The authors elaborated that innovations in financial saving instruments available to investors — providing both safety and returns — appear to have resulted in diversification of financial assets.

Growth determinants

Consequently, there has been growing popularity of mutual funds and other stock market instruments, and a waning of the traditional preference for physical assets such as real estate and gold.

Therefore, opposing movements between Sensex returns and deposit growth are indicative of substitution effects.

“Empirical evidence puts forward several interesting facts about the behaviour of bank deposits. First, it underscores the income as its most important determinant, in both the short- and the long-run. Second, interest rate matters for deposit mobilisation, but only at the margin,” the study said.

“Third, financial inclusion has a boosting effect on deposit mobilisation over the long-run, suggesting expansion of bank branches in un-banked areas. Fourth, substitution effects associated with Sensex returns for deposit growth are limited to the short-run, warranting a careful appraisal of regulatory reforms and tax arbitrage, even as efforts need to be intensified to make both more market-determined,” the study said.

Finally, similar to Sensex return, small savings substitute bank deposits in the short-run, but supplement deposits in the long-run.

This reflects that limits on income tax exemption eventually evens out substitution effects, allowing income to be the key determinant of both in the long-run.