Falling deposit growth: The rot is in the branch
RBI must look in the mirror to see how a lack of regulation of third-party sales and inadequate competition in the banking industry led to the current situation
Alarm bells rang earlier this year within the ministry of finance and the Reserve Bank of India (RBI) over slowing deposit growth at a time when credit growth was robust. Banks need the fodder of fresh deposits to keep lending going. As Indian economic activity picked up after the Covid shock, and with both bank and corporate balance sheets getting cleaned up, there has been a pick-up in bank credit. But, over the past decade, a mix of investor choices and an increased focus on third-party product sales by bank branch staff have reduced the growth rate of deposits. The fall is sharp enough for both RBI and the finance minister (FM) to worry about it. In fact, the FM met the heads of public sector banks this week and asked them to use innovative methods to drive deposit growth. Though recent data shows a small uptick, the underlying problem of bank deposit growth slowing over the long term has deep roots: Lack of innovation, rules that punish investors for changing their mind, and a general lack of trust in bank branches due to the hard-sell of insurance products add to the problem. RBI must look in the mirror to see how a lack of regulation of third-party sales and inadequate competition in the banking industry have led to the current situation. The banking lobby’s act of getting the ministry of finance to change tax rules around debt funds in order to make them less attractive to investors as compared to deposits has not done much to nudge investors to change their behaviour. The issue is discussed in my previous column in this paper and can be read at https://shorturl.at/4oJMC.
It is everybody’s experience that bank branch staff are highly incentivised to sell life insurance products. They have steep targets for policy sales and their career growth depends on how well they do in steering people away from deposits into life insurance. They usually sell money-back or endowment policies that can technically have a commission value of up to 100% of the first premium. It’s no surprise that in the financial year 2022-23 (FY23), the first-year premium through the banking channel totalled nearly ₹81,000 crore. This is 5.5% of the total bank time-deposit growth over the previous year. If the investors who were sold insurance had done a fixed deposit (FD) instead, time-deposit growth would have been higher by 5.5% or almost ₹81,000 crore.
RBI has taken a view that the oversight of third-party sales (insurance, mutual funds) rests with the product regulators, but does not answer the question of how another regulator will monitor the behaviour of bank staff. RBI has not put in place an effective penalty structure for unsuitable sales of third-party products through the bank branches. A toxic experience in the branch serves to reduce trust in banks and nudges investors to seek other avenues of accessing investment products outside of the banking pipelines. This too should worry banks since they are large distributors of mutual funds, selling to individuals around ₹1.9 lakh crore worth of mutual funds in FY24.
In addition to issues of trust, there are also unfair rules that punish depositors for changing their mind mid-way in a fixed deposit. For example, if an investor breaks a five-year FD at the end of two years, she loses about 1% in interest — that is fair. But she also loses the five-year deposit rate and gets paid out interest for a two-year deposit. But she has already paid tax on the interest income as calculated for a five-year deposit. By comparison, in a debt fund, she would get the mark-to-market price on the day of the exit, making that option more attractive to the non-risk-averse investor.
Another factor is the lack of innovation in attracting deposits. FDs remain a suitable product for money needed within three to five years and are a great product for keeping emergency money for millions of middle-class Indians. Making the FD a targeted goal-oriented product and selling it like that would possibly make the more financially aware middle-Indians more open to the use-case of the product.
Finally, banks will have to compete in a very aggressive financial market where there are plenty of choices of products and pipelines that connect people to products. Most banks give access to mutual funds through their platforms but mostly sell regular plans — or those that carry trail commissions. But, along with this cost, the required advice on portfolio construction and management is seldom available. Savvy investors prefer to go directly through apps or other platforms that allow the choice of a direct plan that has no transaction fees or trail commissions. In a competitive marketplace, relying on the strength of lobbying to get tax rules changed to benefit deposits is a short-term win for the banks and RBI.
Banks actually are poised in a strategic place to offer advice to investors to manage their portfolios. There is still trust in the institution and the branch network allows for the use of technology-aided advisory service that keeps the customer from wandering off elsewhere. The share of the pie will be divided between various assets of course, and there is always a market for the risk-averse investor, but a greater focus on the investor rather than the bank’s current bottom-line will be a longer-term win for both. And finally, how much risk people take with their money should be a matter of personal choice rather than a moral lecture from a regulator.
Monika Halan is the author of the Let’s Talk Money book series.The views expressed are personal