Why Deposit Growth is at a Twenty-Five Year Low

Apr 29, 2016

In this issue:
» The dark side to LIC's investments
» The most anticipated financial event of the year
» Update on the markets
» ....and more!
Tanushree Banerjee, Co-Head of Research

Dear Readers,

Most of you are already familiar with Vivek Kaul's views on India's real estate. Vivek is also the author of a trilogy on the history of money and the financial crisis titled Easy Money (which by the way is highly recommended reading!).

In recent months, Vivek has written several extremely insightful pieces in his Diary on the problems and possible solution for public sector banks in India.

Just prior to the April 2016 Monetary Policy, Vivek also explained why the RBI should not cut interest rate by 1%.

In his latest column, Vivek explains why he believes the promoter interest in new businesses needs to grow to revive deposit growth in banks from 25 year lows.

Happy reading!

Tanushree Banerjee


The Reserve Bank of India releases the aggregate deposits with scheduled commercial bank data every week.

Data released on April 22, 2016, suggests that for the year 2015-2016, the aggregate deposits with scheduled commercial banks grew by 9.72%. This is the lowest in more than 25 years and the second lowest in more than 50 years.

Only in 1990-1991, the year before economic reforms were introduced, had the growth been slower at 9.65%. Also, this is the second lowest deposit growth since 1963-1964. Further, it is only the second time that deposit growth has been in single digits since 1963-1964.

And this is a worrying trend.

Why is this happening? One reason is that household savings as a whole have fallen over the years primarily because of the high rate of inflation that prevailed between 2008 and 2013. The household savings fell from 22.2% of gross national disposable income in 2011-2012 to 17.8% in 2013-2014. More recent data points are not available.

The household financial savings was at 7.5% of gross national disposable income in 2014-2015. As the RBI annual report for 2014-2015 points out: "Growth in aggregate deposits, which forms a major component of money supply, has generally been declining over the years in line with a decrease in the saving rate of the economy. In addition, slowdown in credit growth led to lower deposit mobilisation by banks." Raghuram Rajan, the governor of the Reserve Bank of India (RBI), has also offered another reason, whenever this question has been put to him. When deposit growth was faster inflation was also higher, he has explained. In 2010-2011, the aggregate deposits with scheduled commercial banks grew by 15.3%. The consumer price inflation during the year was at 10.45%. In 2012-2013, the deposits grew by 13.8% and the inflation was at 10.44%.

In 2015-2016, the consumer price inflation was 4.83% and the deposit growth was at 9.72%. Once we look the growth from this angle, suddenly it doesn't look as bad.

In fact, there is another important reason for the fall in the aggregate deposits growth and this reason is not so obvious.

The loan growth of banks (i.e. non-food credit) has been slow over the last few years and this has led to slower deposit growth as well.

In 2015-2016, the total amount of loans given by scheduled commercial banks grew by 10.3%. This was better than the 9.3% growth seen in 2014-2015, but low nonetheless. In fact, the loan growth in the last two years has been the slowest since 1993-1994.

This has had an impact on deposit growth. And how is that? As Michael McLeay, Amar Radia and Ryland Thomas of the Bank of England write in a note titled Money Creation in the Modern Economy:

  • The vast majority of money held by the public takes the form of bank deposits. But where the stock of bank deposits comes from is often misunderstood. One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them. In this view deposits are typically 'created' by the saving decisions of households, and banks then 'lend out' those existing deposits to borrowers, for example to companies looking to finance investment or individuals wanting to purchase houses.

As it turns out, things are not as straightforward as that. As the Bank of England authors write: "Commercial banks create money, in the form of bank deposits, by making new loans."

How is that possible? Let's say an individual deposits money in a bank. The bank uses that money to make a car loan (assuming that the deposit is large enough). The money is deposited into the account of the borrower. The borrower of the car loan uses that money to buy a car and pays the car dealer. The money is deposited in the account of the car dealer. The car dealer in turn uses that money to pay his employees.

The employees when they are paid, money is deposited into their savings bank accounts. Hence, a loan creates more deposits. The employees then withdraw a part of that money to meet their monthly expenditure. They may also transfer a part of their deposit from a savings bank account into a fixed deposit.

A part of the money that the employees withdraw goes towards paying their local kirana wallah (or the mom and pop shop) from where their monthly grocery is bought. A part of this spend again finds its way back into the bank as a deposit.

This multiplier effect essentially ensures that new loans create more deposits. And given that loan growth of banks has been slow, it is not surprising that deposit growth is slow as well. Hence, for deposit growth to pick up loan growth will have to pick up.

And what needs to happen for loan growth to pick up? The simplistic answer is that lower interest rates will lead to higher loan growth. But things are not as simple as that. Interest rates also need to be maintained over the prevailing rate of inflation in order to encourage people to save. Further, lower interest rates do not always encourage people to borrow, as is more than obvious across large parts of the Western world, currently.

What needs to improve is the promoter interest in doing new business for which they need to borrow.

As Mahesh Vyas of Centre for Monitoring Indian Economy wrote in a recent piece:

  • Why do a significantly large number of projects continue to be stalled when most important reasons for phenomenon have already played themselves out? The most prominent reason turns out to be lack of promoter interest. One third of the total investments whose implementation was stalled in 2015-16 was because of lack of promoter interest. Another 15 per cent of the promoters who stalled implementation stated that the current market conditions were unfavourable to pursue their projects further. The two reasons are essentially the same - that these are not very good times to invest.

3.25 Chart of the day

Yet another interesting topic that Vivek has covered in his Diary is the reason one should stay away from buying LIC policies. He writes ...

  • LIC is doing a terrible job of managing public money. Any investment firm should be able to generate average returns greater than the returns on government bonds, at least. It should also be able to beat the inflation. In fact, that is what it is paid a fee for. But that doesn't seem to be happening in case of LIC.

    The investment returns of LIC have been consistently lower than the 10-year government bond returns.

He further adds...

  • LIC now owns 21.22% of Corporation Bank, 14.37% of IDBI Bank and 14.99% of Dena Bank. Again, the question, why should an investment firm managing public money be taking on such concentrated risk? In fact, the Securities and Exchange Board of India(Sebi) regulations do not allow a mutual fund to own more than 10% of a company.

    Why doesn't the same rule apply to LIC as well? Like mutual funds LIC is also in the business of managing hard-earned public money.

According to an article in Mint, LIC has a loan portfolio of Rs 3,700 bn, including debentures and bonds worth Rs 2,700. The government-owned insurer buys these debt instruments from companies that intend to raise money for long-term needs.

Its gross bad loans constituted 3.3% of its debt portfolio during FY15. According to the latest reported numbers, LIC's Non-performing assets ratio stood at 4.2% in December 2015. This is much higher than seen in December 2010. LICs NPAs have seen sharp uptick since then.

LIC compromising Investors and Policy holders' interest

In spite of LIC not being in the business of lending, the non-performing assets on its books is enough to put LIC among the top 10 lenders that have largest bad loans.

On one hand, while LIC has significant stakes in public sector banks, that are terribly hit by the bad assets. On the other hand, the company has invested in the debts of corporates whose recovery is highly questionable.

In the past we have constantly reminded you about how the LIC acts like the government's ATM. The insurance company has a huge corpus built by insurance premiums and ULIP funds. The government has been digging into these funds at its discretion to make its asset sales (public sector IPOs, FPOs and bond sales) a success. LIC has been the single-largest buyer of government bonds over past two years. By acting as a savior for the government, the PSU insurer is clearly putting the interest of its investors at policy holders at risk.


The most anticipated financial event of the year is here. Tomorrow, thousands of value investors all across the globe will descend onto Omaha to attend the annual shareholders' meeting of Berkshire Hathaway and hear their heroes Warren Buffett and Charlie Munger, dish out investment maxims.

Radhika, the Managing Editor of ValuePro, and who's modeled the service around Buffett's investing principles and is doing a great job of it, is happy she won't have to rely on anybody else for updates on the meeting.

For the first time this year, she can hear Buffett and Munger speak right from the comfort of her home. In fact, so can you.

This year, the AGM is going to be webcast live on Yahoo. And therefore, those who can't make the trip all the way to Omaha, could still be able to hear the Oracle of Omaha speak.

Also, please don't forget to log onto Equitymaster.com tomorrow to check out our Warren Buffett specials.


The Indian stock markets are trading on a negative note in the post noon trading session. Sectoral indices are trading on a negative note with stocks from the telecom, realty and auto sectors bearing the maximum brunt. At the time of writing the BSE Sensex is trading lower by 139 (down 0.6%). The BSE Mid Cap index and the BSE Small Cap index are also trading in the red, both down by 0.6%.

4.50 Investing mantra

" Risk comes from not knowing what you're doing." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst).

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