Falling rates land banks in a Catch-22 situation

The Reserve Bank of India’s (RBI) rate cuts have automatically brought down loan rates on 60% of floating rate loans, which are linked to external benchmarks like the repo. However, since term deposit rates can be lowered only at the time of opening or renewing a deposit, banks are forced to slash savings rates more to maintain margins.

“Savings deposit rates are being cut across the banking system and it is not limited to a few players anymore. The reason banks are doing that is because the transmission in savings deposits is immediate, unlike a term deposit which happens with a lag,” said Joy P.V., executive vice-president and country head of deposits, wealth and bancassurance at Federal Bank. Joy said the latest 50-bps reduction in the repo rate will lead to a decline in yield on advances or the average lending rate of a bank’s loans and, there is no option but to cut deposit rates.

Das’s warning

Deep deposit rate cuts could lead to a re-run of last year’s liquidity crunch that prompted former RBI governor Shaktikanta Das to remark in August that “alternative investment avenues” were becoming more attractive to retail customers, and banks were facing funding challenges. “This may potentially expose the system to structural liquidity issues,” Das had cautioned in July.

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To be sure, the liquidity situation is different now than last year, with system liquidity comfortably in surplus.

As rates fall, attracting deposits could become challenging again, bankers said. Large banks like State Bank of India, HDFC Bank and ICICI Bank recently lowered their savings deposit rates to 2.5-2.75%, the lowest since RBI began collecting such data in FY01. While savings deposits earned 4% interest in FY01, the rate stood at 2.7-3% in September 2024.

“Today, deposit rates, especially savings, are very low and a potential depositor or investor is likely looking at all possible options, including deposits, that provide some real rate of return. In that context, a deposit product paying 2.5% will not be seen as an investment product and attract a whole lot of funds,” said Saswata Guha, senior director, financial institutions (banks), Fitch Ratings.

Guha said he was not sure if there are ways other than making deposits more attractive for current and potential customers for greater deposit mobilization.

Casa conundrum

Other bankers are hopeful that faced with macro-economic uncertainties, many investors may stick to safer options such as bank deposits, said Biji S.S., senior general manager and head of branch banking, South Indian Bank. The chief executive of a public sector bank said the lender could go for a 15-20 bps cut in savings rate, joining peers who have already done so.

Larger banks, where product holding and wallet share of the customer, especially on the retail base are higher, have been able to cut rates sharply so far, said Narendra Agrawal, head of branch banking and retail liabilities, RBL Bank. “My sense is most larger banks will cut further by 25-50 bps during the year. However, for the next six months, there could be some pause,” he said.

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The share of low-cost deposits—current and savings accounts or Casa—in overall deposits has been shrinking for sometime now and the March quarter was no exception. Casa ratio of SBI, HDFC Bank and ICICI Bank fell 110 bps, 340 bps, and 40 bps, respectively, between Q4 of FY24 and FY25, as per data compiled by Kotak Institutional Equities.

Cooling credit demand could offer banks a breather for some time. Growth in non-food credit slipped to 10.2% year-on-year in April, down from 19% a year earlier, RBI data showed. However, whenever credit demand picks up, banks will have to push for more deposits, or risk drawing regulatory glare on their credit-deposit ratios. The CD ratio indicates how much of a bank’s deposits are being utilized for loans.

Rebalancing

“If credit demand picks up, banks will need to rebalance their funding mix and mobilize more deposits, particularly retail savings accounts. This could pose a challenge unless banks enhance their competitiveness or offer better digital value propositions,” said Biji.

Biji said that as lending rates decline, maintaining profitability would become more challenging, prompting banks to reduce deposit rates as well. “This downward adjustment (in deposit rates) helps banks align funding cost with reduced return on loans, ensuring that margin remains stable despite a lower interest rate environment.”

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Deposit mobilization has been a challenge in the last couple of years with negative systemic liquidity adding to the woes, Agrawal of RBL Bank said. “Banks have to be innovative in launching new products, be more customer-centric, and provide better hooks to the customer; otherwise, HNI and high-balance customers will move to liquid or arbitrage funds. Service will become a key differentiator between banks too, as it is not entirely a rate game,” Agrawal said.

Experts also said that mobilizing deposits will remain a challenge even on the term deposit rate front.

Smaller banks

“How do you convince depositors who are coming out of 7.5-8% term deposit rates from the last two years to now put money at 6-6.5%?” wondered Anil Gupta, senior vice-president and group head of financial sector ratings, Icra.

According to Gupta, smaller banks who were offering 7% rates will be the ones who will cut the saving rates by a larger quantum, because money market rates and liquid fund rates have fallen even more. Their flexibility to cut the rates is higher on saving accounts because their competition is the money market, said Gupta, adding that while bigger banks will have less room, their depositors are more sticky as the customers are not money market or interest-rate sensitive.

“If the deposits (for large banks) remain stable at 2.5%, these banks will not hike savings rates by as much in the next rate hike cycle. So, it is possible that 2-2.5% will become a new normal for savings deposits,” Gupta said.

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As such, the banking sector is entering a phase of slower growth both on the credit and deposit side till banks are able to reprice their deposits and lend at a good margin, said Gupta, who estimates system credit growth at 10.4-11.3% for FY26.