Fitch Ratings said there may be structural changes in Indian banks’ long-term funding mix and cost, with the share of borrowings expected to continue to rise gradually within the overall funding mix, putting pressure on funding costs over the medium term.
“We expect the share of borrowings will continue to rise gradually within the overall funding mix, from its current 10 per cent, if the banks fail to attract sufficient low-cost long-term resources to finance loan growth,” said Fitch Ratings’ Saswata Guha, Senior Director; and Prakash Pandey, Associate Director, in a report.
While low-cost deposits’ migration to term deposits is usual under high interest rates, the former’s share in fresh deposits fell to 20 per cent in the financial year ended March 2024 (FY24), a two-decade low, per their assessment.
The rating agency officials observed that bank deposit rates have been slow to respond to FY23’s 250 basis points (bps) policy rate hike. Term deposit rates have risen by only 234 bps since March 2022, while low-cost deposits rates remain unchanged.
They cautioned that there is a risk that the recent sharp rise in the loan-to-deposit ratio (LDR) may persist as a structural issue if future deposit growth is constrained – due to low/negative real return on deposits and evolving depositor preferences amid inflationary pressures, and high loan growth.
Deposit growth matched loan growth at a 9.4 per cent CAGR (compounded annual growth rate) between FY14-FY24, but LDR has risen by 10 percentage points (pp) since FY21.
The officials emphasised that normalisation of previous liquidity excesses necessitates that banks focus on growing deposits.
Fitch considers banks’ current deposit pricing strategy unsustainable over the long term, if deposits must support the economy’s high reliance on bank credit.
“We expect no imminent pressure on Viability Ratings, given headroom, but individual key rating factor scores may have to be reassessed if the impact on margins, growth and liquidity management is beyond Fitch’s base case,” the officials said.
Higher Retail Flows in Investments
Fitch noted that mutual fund (MF) investments have grown by a 24 per cent CAGR since FY17. The agency assessed that sustained capital-market performance could accelerate the shift of retail savings to investments. Demographic shifts and digitisation may also spur the move away from bank deposits.
The officials opined that a widening of the depositor base from the top 15 urban centres – 65 per cent of MF assets, 44 per cent of bank deposits – could augment inflows and support banks’ deposit retention.
Margin Pressure and Risk Appetite
Fitch said a continued sharp rise in the LDR could intensify margin pressure beyond its expectations. Indian banks have limited pricing power, which may prevent full pass-through of increased funding costs without additional risk-taking, it added.
Liquidity Stance
The officials said sustained easing of the Reserve Bank of India’s liquidity stance, or higher government-linked inflows, could ease pressure, as in the past, but declining flows due to lower real return on deposits could raise pressure on LDR and asset/liability management.