Who wrote this article?

Deepak Shenoy, Capitalmind's research team.

What does the "A Summary" section say?

The Credit Deposit Ratio, an introduction The past: Government Takes a Big Chunk in 2003-05 Oh but wait, we've just seen a spike in that now! Bank Credit Growth slows to less than 15%, while Deposits are growing at 16%+ Tada! The Incremental Credit Deposit Ratio Whoa, Look how much that has fallen! Good CASA times for banks are over. Everyone's moving to Term Deposits And more

Macronomics: Bank Credit and the Sudden Drop in Incremental Credit to Deposits

In another round of Macronomics, we’ll take a quick look at Bank Credit, Deposits and how our Banking System is doing currently.

A Summary

The Credit Deposit Ratio, an introduction
The past: Government Takes a Big Chunk in 2003-05
Oh but wait, we’ve just seen a spike in that now!
Bank Credit Growth slows to less than 15%, while Deposits are growing at 16%+
Tada! The Incremental Credit Deposit Ratio
Whoa, Look how much that has fallen!
Good CASA times for banks are over. Everyone’s moving to Term Deposits
And more

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Let’s look at Bank Credit in some more detail. Every week we know the state of the banking system. That is, the total amount in all deposits in the country, the total money lent out, and the

We know what credit is, and what deposits are.

You deposit your money in a bank. The bank lends it out, to me. I take the loan, and put the money into my account, in another bank. That bank then lends it out again. And so on. This is the process of money creation and it’s not endless, because 4% of every deposit sits in the RBI earning no interest (and can’t be lent out) as part of the “Cash Reserve Ratio” requirements.

Credit and deposit will grow, pretty much hand in hand, in an ideal circumstance. But remember that Credit in India is dependant on another criteria: the Statutory Liquidity Ratio. Banks are required to lend out more than 20% of all deposits to the government, by purchasing bonds called “G-Secs” - or government securities.

Since the SLR+CRR portion is not exactly Bank Credit (CRR is just a dumb asset, SLR is classified as an “investment”) only the portion left beyond the SLR+CRR is there to lend. This consists of mainly deposits, but also includes the capital of the bank itself. Assume the Bank had Rs. 100 in capital, and you gave it Rs. 1000, it now has Rs. 1,100 to lend. The SLR/CRR ratios only applies to the Rs. 1000 you deposited.

Any further shortfall is made up by overnight or “repo” lending from the RBI, or at an individual bank level, the liquidity markets like Call, Term or CBLO markets.

Credit Deposit Ratio over 20 years

One interesting way to look at the banking system is: How much is being lent out, as a percentage of the total deposits in the system? Answer:

The red line above signifies the limit that constitutes (100 minus [SLR + CRR]). Which means, how much of your deposits were you allowed to lend out? in 1994, that number was 50%, in 2003, 70% and now around 73%. (Today, CRR is 4% and SLR is 23%, adding up to 27%, leaving 73% to lend out).

Read the red line as: **Banks could have lent upto this much. **

(Where they’ve lent more, they have either borrowed from the RBI, or used more of their capital or both)

The times that India has seen high credit demand is around 1995, and then since 2006, with a brief lull period in 2009.

What happened during the 1997 to 2005 times? It’s a confusing time, but there is one part where the government took a big chunk of the deposits as credit for itself.

As a percentage of all bank liabilities, demand+time, Government credit spiked between 2003 to 2005, getting more than 35%.

This might sounds bad, but this was a time when the government’s deficit was very tiny (less than 3.5% of GDP) versus now when the deficit seems like it’s 5%.

In fact one of the things to watch out for now is the fact that government borrowing seems to have spiked suddenly.

While this is still below the highs of 2009, one wonders how come this is so high. The answer is that:

Credit Growth has Slowed Considerably

We’ve touched upon this before, but the year on year growth in bank credit (of the entire banking system) has slowed to less than 15%, as of 29 November 2013.

Perhaps the high interest rates are not atrracting demand. Perhaps banks have over-lent to certain sectors and are holding back on further lending. Perhaps there are too many defaults in the system that have been “evergreened”. Or, banks are simply not find enough opportunities to lend.

But are deposits slowing? Absolutely not.

Much of this growth comes from the fact that RBI has bought effectively $10 billion from banks (part of the FCNR swap) since September. This introduces Rs. 60,000 cr. into the system, as the RBI prints rupees to buy these dollars. Those rupees are now lying around as deposits in the banking system.

What are banks doing with the excess cash then? Answer: pump it into government securities, which are yielding about 8.5% at both the short term and the long term. No wonder there’s a spike in that and a dip in credit growth.

The Incremental Credit Deposit Ratio (ICDR)

Calculating the C/D ratio doesn’t tell us much about Flow. If we were to take a period and say - How much Deposits were added in that period? How much Credit was additionally given? Then the ratio of such an incremental Credit and Deposit tells us if banks are stressed for liquidity or not.

This number has reached a three year low. At 68% it’s even lesser than the 73% that would have balanced things out (that is, 27% of all deposits are gone to SLR+CRR, so 73% was available to lend).

Banks are now seeing less demand and the ICDR is giving another signal that liquidity is much easier to come by, and banks aren’t finding adequate avenues to lend or don’t want to.

The Good CASA Times May Be Behind us.

At the same time, bank customers are getting smarter. People are now keeping lesser and lesser money in “demand” deposits (current accounts and savings accounts, or CASA). From nearly 20% in 1995, the system has steadily cut into demand deposits as a percentage of total deposits:

(Ratio of demand deposits to total deposits)

With more term (“time”) deposits, bank cost of funds will go up (CASA accounts are about 0%-7% max interest payable, whereas term deposits earn more than 8%).

In the near term, demand deposits have fallen considerably:

Impact

**The banking system seems to be going thr

ough an inflexion point. **After years of liquidity pressure, banks are now seemingly under less stress. An important note here is that credit demand has slackened considerably.

For one,** this is good for controlling inflation temporarily.** A lack of credit demand, if it continues this way, means lesser inflation. It also means lower growth, though we’re already fairly low in India.

Secondly, interest rates are slowing turning positive in real terms (that is, they are greater than inflation) . So people are moving their money from savings accounts to term deposits. With both market rates and deposit rates high, and a slowdown in credit growth, and banks having to put money into government investments, bank margins are getting squeezed. (Think of it like this: Banks give credit at 10%+, but what they earn from putting into government securities instead is just 8.5%) This will be visible in the next quarter.

Thirdly, the lack of credit growth signifies a continuing economic slowdown. Remember that financing has been a huge part of GDP growth in the last few quarters. Its contribution will reduce. If something else doesn’t come to take its place (Agriculture or other non-credit based sectors) we might see a GDP print below 4.5% again.

Finally, the fiscal deficit is a serious issue, and we have already crossed 84% of the deficit for the year in the first 7 months. Any further rise in government spending will widen the deficit, and that will be bridged by additional borrowing. Meaning, banks will get to buy even more government securities, in the next few quarters, which will squeeze out private demand even more.

This doesn’t bode all that well for banks in the near term. Accompanied with fears of big defaults that are hidden in the system, I wouldn’t touch the world of leveraged financial players.

But it is actually good for the longer term growth of the economy. If not for a high fiscal deficit, inflation and interest rates might have to come down due to the lack of demand. The inflexion point means that it will be the smaller industries and less leveraged players that drive us in the year ahead.

Disclaimer

Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion.

Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.

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