How Bank Credit and Deposit Growth Channel India’s Economic Flow
People respond to incentives.
In his insightful book The Armchair Economist, Steven Landsburg asserts: "The essence of economics can be captured in four words: 'People respond to incentives.' All else is merely elaboration.”
The dynamics of bank credit and deposit growth in India are not random occurrences but rather the collective result of economic agents responding to a complex interplay of incentives – from monetary policy signals and regulatory mandates to market forces and individual preferences. Landsburg’s concise statement aptly captures the fundamental driving force behind these economic flows
What: The Economy’s Circulatory Network:
Economics is largely about the surprising and sometimes tragic consequences of rational behavior. Individuals and firms act rationally within their own contexts. Savers deposit money in banks to earn interest, and safety of their returns. Borrowers, including businesses and households, take credits to meet needs or seize opportunities, expecting to generate income to repay them.
Now if you think of the banking system as the circulatory system of the economy. Credit is like the flow of blood, carrying oxygen and nutrients to different parts (economic activities). Deposits are like the blood volume, the total resource available for circulation.
The growth trajectories of bank credit and deposits are fundamental indicators of the health and dynamism of a nation's financial system and its broader economy.
Why: Are They Related? The Economic Heartbeat
Aiming for a $5 trillion economy, India needs this circulation. Credit nourishes infrastructure (e.g., Bharatmala roads) and manufacturing (Make in India), while rising incomes replenish deposits. Landsburg might call this “efficiency in allocation”—banks pump funds where incentives align with growth.
Under the Reserve Bank of India’s (RBI) rules (e.g., 4.5% Cash Reserve Ratio), banks keep a fraction of deposits as reserves and circulate the rest as credit. A ₹1,000 deposit in Punjab National Bank might pump ₹900 to a shopkeeper, whose payment to a supplier refills another bank’s volume. This multiplier effect mirrors Landsburg’s view: “Most of economic theory is about finding the implications of people doing what they want to do.” Indians save and borrow, and banks amplify that pulse. “When you tax something, you get less of it; when you subsidize something, you get more.” Subsidies like PM-KISAN’s ₹6,000 yearly payout fuel deposits, while cheap credit accelerates borrowing.
The Current Status of Indian Credit-Deposit Flow
Over the last decade, the credit growth has frequently exceeded deposit growth, leading to a gap that banks have had to address through other funding sources. This trend indicates a strong demand for credit in the economy, potentially fuelled by economic growth and investment, that hasn't been fully matched by the pace at which deposits are being mobilised. A prolonged period where credit growth significantly outstrips deposit growth can have several implications for the banking system, like -
A widening credit-deposit gap can lead to structural liquidity challenges for banks. Relying heavily on short-term borrowings or CDs to fund lending can make banks more vulnerable to interest rate fluctuations and potential funding crunches.
When banks have to tap into more expensive sources of funding like CDs or interbank borrowings, their overall cost of funds increases.
If the increase in the cost of funds is not fully passed on to borrowers through higher lending rates (due to competitive pressures or concerns about demand), banks' net interest margins can get squeezed. This can impact their profitability and overall financial health.
For instance, as of July 26, 2024, Scheduled Commercial Banks (SCBs) credit growth stood at 15.1%, while aggregate deposit growth was 10.5 per cent. Similarly, as of June 28, 2024, the system-level incremental credit-deposit ratio was 101 per cent, indicating that incremental credit was higher than incremental deposits. To bridge this gap, banks have increasingly relied on alternative funding sources, most notably Certificates of Deposit (CDs). Issuances of CDs saw a significant increase during 2024-25 compared to the previous year. This highlights how banks are incentivised to seek market-based borrowings when deposit growth lags, aligning with Landsburg's principle of responding to incentives.
Growth in Bank Credit
Personal Loans:
Despite a moderation in the unsecured personal loan segment following the increase in risk weights announced in November 2023, the personal loans segment remained the primary driver of overall credit expansion.
Between 2015 and 2023, personal loans registered a compounded annual growth rate (CAGR) of 17%.
The growth in non-housing personal loans peaked at 27.2% in Q2:2022-23 and declined to 19.8% in Q3:2023-24.
Industry:
SCBs’ lending to the private corporate sector, which accounts for nearly a quarter of total bank credit, decelerated during Q2:2024-25 from the high growth registered in the previous quarter. This moderation continued into Q3:2024-25.
Annual growth in bank credit for industry was around 11.8% in Q1:2024-25, compared to 10.7% in Q4:2023-24.
Among major industries, textiles and metals exhibited robust bank credit demand during 2023-24, while credit to infrastructure and chemical industries picked up pace during H2:2023-24. However, sales of petroleum, iron and steel, and cement industries contracted during Q3.
Housing:
On the long-term trend (1999-2023), housing loans grew the fastest within retail credit at ~25%. However, in the second phase (2011-2023), non-housing retail credit emerged as the major growth contributor.
Annual growth in bank credit for housing was around 12% in Q1:2024-25, compared to 8.1% in Q4:2023-24.
Agriculture:
Credit growth to the agriculture sector peaked in January 2024 and outpaced that to the retail sector.
Annual growth in bank credit for agriculture was around 11.5% in Q1:2024-25, compared to 2.4% in Q4:2023-24
Deposit Growth
During the recent monetary policy tightening cycle, the growth in current account and savings account (CASA) deposits was outpaced by the growth in term deposits. The share of term deposits in total deposits rose further to 61.4% in September 2024 from 59.8% a year ago and 57.2% in March 2023. In Q3:2024-25, the approximate annual growth rates shown are:
Term deposits: ~14%
Total deposits: ~9%
Savings deposits: ~5%
The incremental credit-deposit ratio
This ratio provides insights into the relationship between lending and deposit-taking activities of banks. It is a measure of the efficiency with which banks are deploying newly mobilised deposits into loans over a specific period-calculated as the ratio of the increase in credit to the increase in deposits during that particular period.
Ratio increased to 91.6% as on January 24, 2025, from 80.7% at the end of October 2024. This rebound suggests that credit growth picked up relative to deposit growth again in early 2025.
Why Credit is Important for Indian Economy?
Credit growth is indeed a crucial element for the Indian economy, acting as a significant driver for investment, consumption, and overall economic activity.
Investment: India’s economic growth hinges on capital formation—building roads, factories, power plants, and digital networks. Businesses, especially in capital-intensive sectors like manufacturing or infrastructure, often lack the internal funds to finance these projects.
Consumption and Demand: Incomes often lag behind aspirations, making credit a rational choice for households to smooth consumption over time. Personal loans, including housing and vehicle finance, have grown at over 15% annually, driving demand that sustains industries like real estate and automotive manufacturing, which together employ millions.
Amplifying Monetary Policy and Economic Cycles: Without credit growth, monetary policy loses its punch. If banks hoard funds or borrowers shy away, rate cuts fail to stimulate demand, and the economy stagnates—a rational but costly outcome for all involved.
So, what’s the conclusion?
Deposits will not grow unless credit grows. Every loan creates a new deposit in the borrower’s name or adds to their account balance. This implies that credit growth can indeed contribute to deposit growth within the banking system. Money begets money as loans are disbursed and then held as deposits.
Banks' Strategies in Response to the Gap. By Increasing term deposit rates to attract more deposits. More than two-thirds of term deposits were earning 7 per cent and above.
Personal Loans has been a significant driver of overall credit expansion. Up to September 2024, personal loans (housing and non-housing) remained the prime contributor. However, following the increase in risk weights announced in November 2023, there has been a moderation in the unsecured personal loan segment. Now, we need this to grow back.
"People respond to incentives" sounds innocuous enough, and almost everyone will admit its validity as a general principle. What distinguishes the economist is his insistence on taking the principle seriously at all times. -Steven Landsburg
India is primary consumption driven economy, and too much tightening up of the credit is not good for us. Eventually, People respond to incentives.
Another Landsburg’s wisdom
If your common sense tells you otherwise, remember that common sense also tells you the earth is flat. -Steven Landsburg
Steven Landsburg wrote another interesting book More Sex Is Safer Sex: The Unconventional Wisdom of Economics (2007). In this he argue that increasing sexual activity among low-risk individuals could paradoxically reduce the spread of sexually transmitted diseases (STDs) like HIV. Landsburg argues that if cautious, typically abstinent people—those less likely to carry infections—entered the dating pool more often, they’d dilute the concentration of high-risk partners, lowering the overall infection rate. It’s a counterintuitive twist on incentives: by encouraging “safe” people to have more sex, the risk per encounter drops for everyone.
Now, if I have to extend this, to this post. More Credit is Safer Credit for Indian economy, not the other way.