India Banks Choke on Funding as Small Savings Schemes Trump Market Rates
Overview
India's banks face a critical funding challenge as deposit growth trails loan expansion. Government-backed small savings schemes offer higher rates than banks can sustainably match, distorting the market and forcing reliance on expensive, unstable borrowings. This structural imbalance squeezes margins, slows policy transmission, and restricts lending capacity.
Funding, not credit, is the primary constraint for India's banking sector today. Deposit growth has consistently lagged loan growth for several quarters, compelling banks to increasingly rely on costlier market borrowings and certificates of deposit. This reliance is unsustainable and puts pressure on profitability.
The Small Savings Distortion
At the heart of this imbalance are government-backed small savings schemes. These instruments offer rates that commercial banks find challenging to match without incurring significant margin losses. Their safety, convenience, and often tax advantages make them highly attractive to households, creating a structural disadvantage for banks and setting deposit rate expectations above market realities.
Squeezed Margins and Lending Caution
When banks cannot mobilize deposits efficiently, their net interest margins are compressed. This also slows the transmission of monetary policy, as banks become more cautious with lending. The cost and uncertainty of funding directly impact their ability to lend, particularly to vital sectors like MSMEs, where predictable guarantees and recovery mechanisms are crucial.
Public Sector Banks' Calculus
Public sector banks, though well-capitalized, are not immune. Growth pressures can test their buffers. Predictable funding structures and clarity on deposit mobilization would enable them to lend with greater confidence, avoiding cycles of over-caution or forced expansion.
The Path to Stability
Restoring financial stability requires more than forbearance. A constructive reform involves aligning small savings rates with broader market conditions. This would allow banks to price deposits on commercial terms, paving the way for improved lending, healthier margins, and sustained financial stability.
