Indian households flock to markets for higher yields, squeezing bank deposits

By: Shantanu Bhattacharji

Shrinking deposits may push banks toward corporate bonds, securitisation, or wholesale funding, raising borrowing costs. Persistent trends could tighten credit, slowing loan growth and economic momentum.

Indian households, long reliant on bank deposits, are increasingly chasing higher yields in equities, mutual funds, and insurance products. This pivot, driven by persistently low deposit rates and booming stock markets, is eroding banks’ traditional deposit base, raising concerns over liquidity and credit expansion. The Finance Ministry’s warning highlights the risks: many retail investors, lacking financial literacy, may underestimate market volatility, while banks could see funding costs rise as cheap deposits shrink.

The government is likely to respond with tighter regulations on investment products and a push for financial education to shield retail investors. Banks, in turn, may need to hike deposit rates to retain savings or tap alternative funding channels such as bonds and wholesale deposits. A prolonged shift could nudge lending rates higher, affecting credit growth and broader economic momentum.

With deposits being a primary source of low-cost funding, banks now face the risk of rising capital costs, compressing margins and pushing lending rates higher. The Reserve Bank of India (RBI) could step in with liquidity management measures. Adjustments to the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) could help stabilise liquidity.

More significantly, the retail-driven equity rally could see increased volatility, especially if inexperienced investors exit during downturns. A prolonged shift may also reduce banks’ role in financial intermediation, pushing more funding toward capital markets.

To offset shrinking deposits, banks may rely more on corporate bonds, securitisation, or wholesale funding, which could elevate borrowing costs. If the trend persists, banks could tighten credit, slowing loan growth and potentially affecting economic momentum. The challenge for regulators will be to balance financial deepening with banking sector stability.

The parliamentary standing committee has flagged the fallout of declining household savings in banks, urging proactive measures to address liquidity concerns. With the shift toward market-linked instruments eroding banks’ current account savings account (CASA) base—a key source of low-cost funding—margins are tightening, and funding costs are rising.

Experts are of the view that to counter the CASA decline, banks may push for deeper penetration in underserved areas, introduce higher-yield savings products, and leverage technology to enhance operational efficiency. Expanding digital banking services could improve customer retention and deposit mobilisation.

The surge in complaints under the RBI’s Integrated Ombudsman Scheme—growing at nearly 50 per cent annually to 934,000 in 2023-24—underscores rising consumer dissatisfaction with banking services. The spike reflects challenges in digital transactions, fraud, service inefficiencies, and dispute resolution. As financial services diversify, grievances spanning multiple sectors add complexity, exposing gaps in consumer protection frameworks.

With banking services expanding digitally, ensuring seamless grievance redressal will be critical to maintaining confidence in the financial system. The challenge will be aligning customer protection with the rapid evolution of digital finance.

Meanwhile, bank credit to the personal loan segment cooled to 14.9 per cent year-on-year in December 2024, reflecting a slowdown in ‘other personal loans,’ vehicle loans, and credit card outstanding, as per the RBI data.

Higher EMIs and cautious sentiment could keep discretionary borrowing subdued, particularly for big-ticket purchases such as vehicles. Credit card spending may also moderate as consumers prioritise debt management.

While overall banking credit remains healthy, the cooling in personal loan growth signals changing consumer dynamics. The challenge for banks will be balancing risk with growth as they navigate this shift.