Liquidity restrictions could make banks more competitive for deposits.

Indian banks may be compelled to compete harder to increase deposits as a result of tumbling liquidity . Banks relied on money markets to satisfy the remaining demand for credit over the past few years .

MUMBAI (MUMBAI): Analysts cautioned that Indian banks may be compelled to compete harder to increase deposits as a result of tumbling liquidity and increasing credit demand ahead of the festive season.This week, the banking system liquidity fell into deficit for the first time in almost 40 months, prompting the Reserve Bank of India to pump funds into the system.The true problem, according to Suresh Ganapathy, head of financials research at Macquarie, is the gap between deposit growth and loan growth, as deposit growth is slow at 9.5% YoY, a good 600 bps below loan growth.Liquidity will tighten even more in the next few weeks as the festive season begins to warm up.

Bank loans increased 15.5% in the two weeks to Aug. 26 from a year ago, while deposits increased 9.5%, according to RBI data earlier this month.Due to the RBI's cash infusion during the pandemic, banks relied on money markets to satisfy the remaining demand for credit over the past few years.However, with credit growth at multi-year highs and the RBI focusing on draining liquidity to curb inflation, the cheaper financing options are drying up.Due to the lack of liquidity in the market, banks have been slow in raising deposit rates, but lending rates were raised instantaneously, according to L&T Financial Holdings chief economist Rupa Rege Nitsure.

The excessive reliance on bulk deposits is detrimental to the economy's overall financial stability, she said.Bankers agree that relying on the debt market to raise funds to support growth isn't sustainable.Borrowing from the market to finance credit development is just one of the ways, and it isn't sustainable for a while.In the coming months, we will have to begin raising rates more aggressively, according to a state-owned bank senior executive.

Other bankers agreed.Rates for bulk deposits, or deposits of more than 20 million rupees, are increasing faster than retail, showing that banks are focusing on raising more money faster.In August, the State Bank of India's 1 to 2-year retail term deposit rate increased by 15 basis points to 5.45%, while the bank increased the bulk deposit rate for the same tenor by 75 bps to 6%.Credit growth tends to accelerate in the second half of the year, and with the festival season and economy improving, we expect a high demand, so deposit mobilization will increase, according to another banker.

The incremental credit deposit ratio has already reached 100%, meaning that banks are now lending more than they already have total deposits.As the gap between lending and deposit rate narrows, lenders may experience a drop in margin in the next few months, but it will be a short-term effect, as banks will be able to pass on the cost to the borrowers, according to ICRA analyst Karthik Srinivasan.