Indian banking's problems with growth

The next big battle will be fought for deposits

In 2003, a civic body in Maharashtra severed its decade-old tie with a public sector bank. The reason? The bank was unwilling to lend about Rs 90 crore for a road project at a rate that the civic body was demanding.

The bank could not oblige the borrower because it lacked a sufficiently high rating to justify the fine pricing of the loan. The peeved civic body decided to go shop elsewhere and actually auctioned the loan. Five commercial banks committed to offer the loans at record low rates.

This year, the same civic body asked for quotations from commercial banks in sealed envelopes once again. This time, though, the "tender" was not for raising money but to park its surplus funds with a bank that offered the highest interest rate.

These two incidents mark the beginning of a fundamental shift in the business of banking over the past year. Till recently, Indian banks were knocking at the doors of corporations hawking loans.

Today, it's the banks that have started begging for deposits and not loans any more. The reason? The industry's credit portfolio is growing at a scorching pace, far ahead of its deposit growth. This has never happened before.

In the first nine months of the fiscal year 2004-05 (that is, between April and December 2004), non-food credit of all scheduled commercial banks grew by Rs 1,92,548 crore.

On a year-on-year basis (that is, between December 2003 and December 2004), the non-food credit growth was even higher "" Rs 2,58,274 crore. Against this, the deposit growth is Rs 1,61,1041 crore and Rs 2,43,561 crore, respectively.

This means that the Indian banking system's incremental credit-deposit (CD) ratio for the past one year has been over 100 per cent. Part of the high non-food credit growth is on account of conversion of Industrial Development Bank of India (IDBI) into a bank.

However, even after excluding IDBI's portfolio, the banking sector's credit growth is much higher than its deposit mop-up.

In percentage terms, the aggregate deposit growth in the first nine months of the year has been 10.7 per cent against 23.9 per cent credit growth.

This is, however, slightly misleading because the base of the banking system's deposit portfolio is much higher (Rs 16,65,457 crore) than the outstanding credit portfolio (Rs 9,97,371 crore).

Nonetheless, it is a significant trend. The banks have finally come back to their bread-and-butter business of giving loans. Growth in deposits is not matching the frenzy for loans.

Despite a small rise in lending rates, corporations are lapping up bank funds but savers are going to greener pastures like post office-run small savings schemes that offer better returns.

The growth in the investment portfolio is the least in the first nine months of the year. Between April and December, the banking industry's investment book grew by just Rs 22,954 crore.

The comparative figure in the first nine months of the previous year was Rs 98,838 crore. In percentage terms the growth is 3.4 per cent. Since 1995-96 (from when the Reserve Bank of India's weekly statistical supplements are available on the Indian central bank's website), the lowest growth in the banking industry investment portfolio recorded was 10.4 per cent, in 1995-96.

It grew by over 22 per cent at least three times "" in 2000-01, 2002-03 and 2003-04. In the past two years, the investment portfolio of the banking industry jumped by over Rs 1 lakh crore.

With the first sign of rising interest rates, Indian banks have shifted focus from investment in government securities to loans. On an outstanding basis, the credit deposit ratio is 62.54.

In other words, for every Rs 100 worth of deposit in the system, Rs 62.54 is being disbursed as credit. This has never happened before, at least not in the past one decade.

Let's take a close look at the non-food credit figures. The nine-month growth in non-food credit is higher than in any full year's non-food credit growth over the past one decade.

Leaving this year apart, since 1996, only twice has the banking sector's non-food credit growth been over Rs 1 lakh crore in a full year. In contrast, deposit accretion exceeded Rs 1 lakh crore for seven consecutive years from 1998-99.

Where is the credit going? Opinions vary. K C Chakraborty, executive director of Punjab National Bank, says that steel and cement, and construction sectors are aggressively raising bank loans. The shopping malls are big guzzlers of credit.

A senior State Bank of India official singles out retail and oil as the two most important segments where the credit is flowing.

Retail loans account for 40 per cent of the country's largest commercial bank's incremental credit; agriculture and corporations, including oil, 25 per cent each; and small and medium enterprises (SMEs) the rest 10 per cent.

In the case of ICICI Bank, retail loans account for 61 per cent of the total growth in the loan book this year. In the first nine months of the year, it has disbursed Rs 13,147 crore worth of home loans, which is roughly 40 per cent of the total outstanding home loan portfolio of the Housing Development Finance Corporation (HDFC), the 27-year-old pure mortgage player in India.

If the pace of credit growth continues, some of the banks will run out of the raw material for building assets "" money. No wonder banks have started chalking out special deposit mobilisation plans.

The last time they undertook such an exercise was in 1995-96, when growth in deposits just managed to take care of the non-food credit growth (Rs 46,961 crore versus Rs 44,938 crore)

Companies and high net worth individuals have started bargaining for a few paise more on their deposits and banks are obliging them without making a fuss.

Traditionally, public sector banks mop up money from across the country using their wide branch network, and foreign and a few private banks buy this money (in the inter-bank market) to build short-term assets.

This trend is unlikely to be repeated because the credit demand is picking up in every pocket. Banks are also offloading their excess statutory liquidity ratio (SLR) holdings to generate liquidity to support new loan asset creation. But even that will not be enough if the pace in credit growth does not slacken.

The next battle on the Indian banking turf will be fought for deposits. The fight for deposits will be intense in Mumbai, Delhi, Chandigarh, Goa, Punjab, Gujarat and Kerala.

Delhi is among the top cash-rich pockets with per capita deposits of Rs 1,14,090 "" more than eight times the national average of Rs 14,131 in March 2004.

Chandigarh follows closely with per capita deposits of Rs 1,06,505. The next are Goa with per capita deposits of Rs 59,282; Punjab Rs 25,259; Kerala Rs 19,990; and Gujarat Rs 16,586.

The per capita deposit figure for Mumbai is not available but the figure of Rs 34,010 for the entire state of Maharashtra should give an indication of the per capita deposits in the country's financial capital.

Till now loans were auctioned to those banks that charge the lowest interest rates. Now companies have started auctioning deposits to the highest interest payers. There is, however, one critical difference.

For loans, borrowers turn to the cheapest lenders but while parking money with banks, the highest interest payer does not necessarily get the deposits. Companies and high net worth individuals also look for safety.

After all, only up to Rs 1 lakh of deposit gets insurance cover. Any money over and above this can vanish into the blue if a financial intermediary crumbles.

So relatively-weak banks may find it difficult to raise deposits even if they offer competitive rates. It is these players that will feel the heat if they are on a massive asset building mission.