Background:

• The current and savings accounts (CASA) are banks’ easy sources of funding and currently account for 41 per cent of total deposits as against 43 per cent in 2022-2023.
• These accounts provide a stable source at a cheaper rate for funding the bank’s needs. In 2024, these deposits are falling due to various reasons.

Factors leading to decline in Deposits:

• Negative Real Returns: In the past decades, household savers received low-interest rates (3-5%) on savings bank deposits, which resulted in negative returns when adjusted for inflation (averaging 6.6%). Savers are now seeking better returns in other asset classes.
• Rising Competition: Increased competition from other financial products offering higher returns, such as mutual funds, equities, and fixed-income instruments, has diverted savers away from traditional bank deposits.
• Technological Advances: The rise of fintech platforms and digital savings tools has provided more attractive and accessible alternatives for savers, contributing to the shift away from bank deposits.
• Deregulation: Over the years, deregulation has allowed for more competitive interest rates in non-bank financial sectors, reducing the appeal of low-yield bank deposits.
• Structural Shift in Saving Preferences: There is a growing structural change in how savers allocate their financial resources, moving away from bank deposits to more profitable asset classes.

Problems for Banking sector:

• Deposit Crunch: The gap between deposit growth and credit growth has led to the worst deposit crunch in two decades. Declining core deposits, particularly in current and savings accounts (CASA), increase banks’ funding costs and strain their ability to maintain liquidity.
• Pressure on Profitability: As deposits shrink, banks are forced to rely on more expensive funding sources, which reduce their profits. Additionally, rising interest rate risks in a “higher for longer” rate environment further reduce profitability.
• Increased Credit Risk: Banks are becoming more cautious with lending due to heightened credit risk. As a result, they are tightening underwriting standards, which can limit credit availability for borrowers and slow down economic activity.
• Strain on Smaller Banks and Intermediaries: Smaller banks and non-banking financial companies (NBFCs) are more reliant on core deposits. Declining deposits affect the cheap funding of these institutions and this may  affect consumption and investment activities.
• Shifting Savings Patterns: Savers are increasingly moving towards higher-yielding alternatives like equities, mutual funds, and other financial products. This shift reduces the inflow of deposits into banks, potentially leading to long-term structural changes in how banks attract and retain funds.

Way forward:

• Banks must offer competitive returns, diversify funding sources, deepen bond markets, enhance digital solutions, and strengthen risk management to navigate the deposit crunch and profitability challenges.