Households don't create deposits, banks do

The slow growth in bank deposits has been a matter of concern, particularly as growth in private credit has outpaced deposits for the last two years now. This has largely been attributed to the decline in household savings or to a shift to physical savings or even a shift to alternate financial savings like mutual funds.

Aggregate deposits are not driven by household savings

However, contrary to intuitive belief, household savings do not create deposits. This seems incompatible with our lived observations as we personally make deposits only from our savings. Statistics such as 60% of Indian bank deposits are from households also propagate a similar narrative.

Source: RBI

The question to be asked though is that how did the individual get this money?

Typically, this is the income received from another individual or firm. The salary a person receives from his employer is the deposit in employer’s account that shifts to his account. He retains part of this deposit in his account (his saving) and spends the rest, i.e. shifts to bank deposit of a shop owner. Therefore, neither spending nor saving has an impact on the total deposits, it just determines in whose account the deposits reside. The money moving from one individual to another within the economy are what economists called “transfers”. Similarly, if rather than a financial saving, he chooses to invest in a physical asset (say a house) or an equity share, the deposit in his bank account would be transferred to the seller’s account.

China for instance has seen deposit growth in its banking system hover around 10% over the past decade despite the household savings rate being sustained at around 35% and nominal GDP growth at 8% (2012-2022).

China & India - Households Savings & Deposit Growth

Source: Morgan Stanley

Banks create deposits

Money and deposits are ONLY created by banks. The central bank creates reserve or high-power money, which is the liability on its balance sheet primarily by printing currency. Additional deposits are created by commercial banks when they extend loans either to the government or private sector. Therefore, aggregate deposits in the economy are emanating from the reserve money created by RBI and the money multiplier based on the credit extended by the commercial banks.

Over the past two years pace of credit extended by banks picked upto 15% and reflected in the money multiplier moving up to 5.4x in FY24 from 5x in FY22.

Source: RBI

However, the pace of money creation (M3 growth) remained unchanged at 10% as reserve money growth slowed to 5.6% in FY24 from a high of 18.8% YoY in FY21. This was primarily due to currency in circulation rising only 4% YoY with the withdrawal of the Rs 2,000 denomination notes.

Source: RBI

Source of deposits matter

In the current regulatory LCR (Liquidity Coverage Ratio) framework, banks’ ability to extend loans depends both on aggregate deposit growth as well as the type and source of deposits. Retail and wholesale deposits have large variance on expected run-off rates in LCR calculations. Therefore, while banks can lend upto 77.5% of retail term deposits, they can lend only about 55% of their callable wholesale deposits.

Source: Axis MF Research

Share of households in bank deposits has only changed marginally from 63% in 2018 to 61% since 2024. Much larger change has been visible in share of government deposits dropping from 14% to 9% and share of corporate deposits increasing from 10% to 18%. The rise in corporate deposits is representative of the turn in corporate profitability that has improved from 2% of GDP in 2018 to 5% now.

Source: Morgan Stanley, RBI

The drop in government deposits is also attributable to the government migrating to a more efficient Just In Time (JIT) model. In order to improve the efficiency of cash management, Central Government has adopted JIT system for release of funds for payments in last few years. This move has resulted in the Government maintaining relatively higher average balances with RBI and commensurately lower balances with banks.

Share of lower cost (CASA) deposits for banks has moderated from a high of 42.6% in 2021 to 38.8% in 2024. This recent moderation can be attributed to shift in savings behavior, though the past ten-year average CASA share for bank has been similar at around 39.2%.

Monetary cycle will drive revival in deposit growth

India’s credit to GDP multiplier has averaged 1.1x. To sustain double digit growth in nominal GDP, the current pace of credit growth will be needed to be met. While concerns abound about weak deposit mobilization limiting credit availability, this appears unlikely to sustain as credit itself creates deposits. With easing inflation and softer global rates, RBI comfort on infusing higher reserve money to boost M3 growth is likely to improve. This will create a virtuous cycle of improved reserve money creation boosting money supply allowing faster credit and deposit growth.

Disclaimer

Source: Axis MF Research, RBI, Morgan Stanley, Bloomberg. Data as on 31 August 2024.

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