Surging credit has caused loan-to-deposit ratios (LDRs) to climb at Indian banks, raising concerns that the trailing deposit growth and competition for funds would hit margins.

Loan growth has stayed strong since the Indian economy recovered from the COVID-19 pandemic. But deposit growth lagged behind as Indian investors sought other asset classes. These include stocks via direct investments and mutual funds as well as real estate, driven by India's position as one of the world's fastest-growing major economies. This has skewed the loan-to-deposit ratios at most banks.

"To us, the lower deposit growth is symptomatic of household stress caused by the weak job market and contracting real wages, especially at the lower half of the pyramid, engendered by the deeply entrenched K-shaped economic recovery," said Kunal Kundu, India Economist, Société Générale. A K-shaped economic recovery is when some sectors in an economy rebound sharply from a recession, while some others continue to decline.

LDRs at top public sector lenders, including State Bank of India, Bank of Baroda Ltd., Punjab National Bank, Union Bank of India and Canara Bank, increased almost every year since fiscal 2021, according to S&P Global Market Intelligence data. While the ratio has declined marginally at some private-sector lenders, this is largely because they were already operating at much higher levels of LDR.

State Bank of India, the biggest lender by assets, saw its LDR rise to 74.79% as on Dec. 31, 2023, from 67.50% at the end of the fiscal year ended March 2021. Bank of Baroda's LDR increased to 82.39% from 76.55% over the same period. Among private-sector lenders, HDFC Bank Ltd. saw a sharp increase in its LDR to 114.02% as on Dec. 31, 2023, from 89.85%, following its merger with Housing Development Finance Corp. Ltd., its non-deposit-taking housing finance parent. But the LDR at peers such as ICICI Bank Ltd. and IndusInd Bank Ltd. edged slightly lower, Market Intelligence data show.

Stressed borrowers

Uncollateralized lending, symptomatic of rising household stress and fears of such loans turning sour, has led the increase in loan growth, Kundu said.

Even the Reserve Bank of India (RBI) raised concerns about surging personal loans as the proportion of such advances increased to 35% in 2023 from 25% in 2007, according to a Jan. 18 research paper from RBI employees. RBI Governor Shaktikanta Das had highlighted during his monetary policy address in October 2023 that certain components of personal loans were recording "very high growth," and advised banks and nonbank financial companies to strengthen their internal surveillance mechanisms.

Indian banks' aggregate LDR reached a two-decade high of 80% in December 2023, S&P Global Ratings said in a Feb. 15 report. While the credit growth rose by a component of 1.5 times the nominal GDP, deposits increased in line with the nominal GDP, according to the Ratings report.

Competition for deposits

As the growth in deposits trails credit expansion, lenders will likely compete for deposits, driving up their funding costs. Coupled with expected policy rate cuts later in 2024, banks' net interest margins will be pressured, Ratings said. The systemwide net interest margins are expected to slip to 2.9% in the fiscal year that will end March 31, 2025, from 3% in the current fiscal year that ends March 31, 2024.

Aggregate deposits with banks increased 12% year-over-year as of Jan. 26 and credit growth stood at 16.1%, RBI data showed. Strong economic growth in India has prompted high demand for credit in the country, with the government estimating the economy will grow at 7.6% in the financial year ending March, following an 8.4% GDP growth in the October-to-December quarter.

Indian banks' incremental credit-deposit ratio remained above 100% in the 12 months to May 2023. A subsequent pick-up in deposits pulled the ratio lower, though it still was as high as 96.9% as on Jan. 26, according to central bank data.

Private sector banks have seen a rapid year-over-year credit growth of 18% over the first half of fiscal 2024, higher than that of public sector banks' 13% expansion in the same period, Ratings data showed.

An additional pressure on the banking sector liquidity would force banks to raise additional capital from the market, "which would push up their borrowing cost and concomitantly the lending rate," Kundu said.

Banks have largely run out of excess liquidity and there is a strong case for loan growth moderation going ahead for the banking system, Nomura said in a Feb. 8 report. While systemic tight liquidity may be transient, the challenge for loan growth from deposit mobilization could still persist over the medium term, Nomura said. It expects loan growth to slow to between 13% and 14% in the fiscal year that will start on April 1, from 16% currently. Ratings expects system-level credit growth to moderate to 14% in the same fiscal year.

Deposits lose favor

Indian investors have been attracted to equities as benchmark stock indexes are trading at an all-time high. India's mutual fund assets doubled to 50 trillion rupees in the December 2023 quarter. This represents a significant increase from 25.5 trillion rupees in the June 2020 quarter, according to the Association of Mutual Funds in India.

Mutual funds saw net outflows in only three of the past 15 quarters, according to data from the association.