Credit Deposit Ratio

Credit Deposit Ratio

Subject: Economy

Section: Monetary policy

Context: Banks need to rework their strategies rising from the ‘business as usual approach’ given the rising cost of borrowing due to hike in the repo rate.

Impact of Rising cost of borrowings:

• Emerging resource imbalance:
  • Declining credit deposit ratio–Deposit growth isat 9.8 percent while credit growth is at 14.4 percent as of July 1 taking the credit deposit (CD) ratio to 73 per cent.
  • Theoretically, when the CRR is at 4 percent and the SLR is at 18 per cent, the CD ratio can be 78 per cent.

Need:

Increase deposit base by:

• Depositor friendly ecosystem
• Digital penetration-
  • Financial inclusion (FI) index of the RBI is 53.9 in March 2021,  still leaving a huge scope for penetration and mobilisation of deposits from hinterland, where people usually do not invest in other financial markets.
• Protection against cyber breach
• Speedy resolution of customer grievances –Implementation of internal ombudsman scheme.
• Building a binding relationship with customers to continuously raise deposit resources.
  • The data of December 31, 2020, indicates that 90 million customer accounts are dormant and have not been operated for over 10 years.
  • There are millions of good customers maintaining nominal balances, perhaps due to lack of efforts on the part of banks to reconnect with them.
• Deposit product reengineering
  • HDFC Bank started  short term deposit products with differential interest rates.
• Better targeting of potential customers lost during pandemic-Rural customers, housewives, senior citizens, with risk averse and former employees
• Doorstep banking services
• Better data collection and analysis-Banks should monitor, incremental rise in new deposit accounts, per account balances, its trends, reasons for low balances
• Skills Development of existing employees to bridge the  Covid has created a void between banks and customers.

Concept:

Credit Deposit Ratio

• It is the ratio of how much a bank lends out of the deposits it has mobilised. 
• It indicates how much of a bank’s core funds are being used for lending, the main banking activity.
• To calculate the loan-to-deposit ratio, divide a bank’s total amount of loans by the total amount of deposits for the same period.
• The regulator (RBI)  does not stipulate a minimum or maximum level for the ratio. But, a very low ratio indicates banks are not making full use of their resources. And if the ratio is above a certain level, it indicates a pressure on resources.
• Typically, the ideal loan-to-deposit ratio is 80% to 90%. 
• A loan-to-deposit ratio of 100 percent means a bank loaned one dollar to customers for every dollar received in deposits it received.
• A credit-deposit ratio of over 70 percent indicates pressure on resources as they have to set aside funds to maintain a cash reserve ratio of 4.5 per cent and a statutory liquidity ratio of 23 per cent. Under such a scenario Banks can lend out of their capital, but it is not considered prudent to do so.

WHY IS IT CONSIDERED A KEY PARAMETER?

• The ratio gives the first indication of the health of a bank.
  •  A very high ratio is considered alarming because, in addition to indicating pressure on resources, it may also hint at capital adequacy issues, forcing banks to raise more capital.
  • Moreover, the balance sheet would also be unhealthy with asset-liability mismatches.
• The loan-to-deposit ratio is used to assess a bank’s liquidity by comparing a bank’s total loans to its total deposits for the same period.
•  LDR helps to show how well a bank is attracting and retaining customers. 
• The LDR can help investors determine if a bank is managed properly. If the bank isn’t increasing its deposits or its deposits are shrinking, the bank will have less money to lend.