Credit Deposit Ratio of Banks

Introduction

The Credit Deposit (CD) ratio is an important indicator for understanding a bank's lending practices, liquidity conditions and overall financial health. It has gained significant attention recently due to the growing gap between deposit mobilisation and credit disbursement. According to RBI, the Scheduled Commercial Banks (SCBs) CD ratio reached a record high of 80.3% in March 2024 and continued to remain elevated in FY2025 thus far. The rising CD ratio due to diverging credit and deposit growth raises concerns about potential structural liquidity challenges within banks. 

In this blog, let us explore why the CD ratio is rising, its significance in the banking sector, and why banks must maintain a healthy balance between deposits and loans.

What is the CD Ratio?

The CD ratio measures the proportion of a bank's total deposits that have been disbursed as loans.  The ratio is calculated by dividing the total loans by the total deposits and represented in percentages. The CD ratio provides insights into a bank's liquidity condition and its ability to fund the credit requirements of the various sectors of the economy. A higher CD ratio means the bank is lending out a larger portion of its deposits indicating higher demand for loans. Also, it could be possible that the bank is unable to mobilise enough deposits to fund the credit demand. A lower CD ratio suggests banks' conservative lending practices, a low-risk appetite, weak demand for credit and higher deposit mobilisation.

Role of CD Ratio in Banking Stability

The CD ratio is one of the important parameters to assess the financial health of the bank. Bank deposits are liabilities for banks, while bank credit or loans and advances are their assets, thus maintaining the balance between deposits and credit (how they have been utilised) is crucial for a bank's operations and stability. It provides valuable insights into:

• how a bank balances its deposit mobilisation with its lending activities
• the effectiveness of the monetary policy transmission
• banks' role in promoting productive sectors of the economy by supporting their credit requirements 

Banks can manage their CD ratios based on their risk management strategies. The CD ratio for a bank varies depending on several factors, including the bank's size, risk appetite, and the economic environment. A higher CD ratio implies greater credit orientation of banks, while a low ratio may indicate the underutilisation of funds and potential missed revenue opportunities. A high ratio also signals liquidity risks and possible difficulties in meeting withdrawal demands. Aggressive lending practices could heighten risks throughout the financial system. According to Ashima Goyal “Credit eventually creates deposits through rising incomes and savings, but in the meanwhile banks should maintain adequate liquidity buffers”. 

A balanced CD ratio indicates that a bank is effectively utilising its deposits to generate income through lending while maintaining sufficient liquidity to meet withdrawal demands. Although there is no mandatory target range for the CD ratio that banks must maintain a ratio between 65% and 75% is generally considered to be healthy according to experts. 

Trends in SCBs CD Ratio

India's banking sector has witnessed a significant rise in the CD ratio in recent years. The merger of HDFC Ltd (HFC) with HDFC Bank effective July 1, 2023, elevated this ratio by ~2.2 percentage points. As of March 2024, the CD ratio reached 80.3%, its highest level in the last 50 years, reflecting the growing gap between credit and deposit growth. In terms of the incremental CD ratio, this has exceeded the threshold of 100% in the last two fiscal years.

Some of the key factors which contributed to the high CD ratio in the recent period:

• Strong demand for credit - Strong economic recovery post the COVID-19 pandemic, has created huge demand for credit. GDP grew by an average of 8% annually in the last three years (FY2021 to FY2024) and outstanding credit increased by an average of 12%. In FY2023 and FY2024, the demand for retail loans such as personal loans (27.5%) and corporate loans (23.5%) also increased significantly, due to increased consumption and greater cash flow needs on account of high inflation.
• Slower deposit mobilisation - Deposits grew much lower by 13.5% vis-a-vis credit growth of 20.2% in FY2024. According to banking experts, there has been a shift in deposit preferences from current account and savings account (CASA) deposits, and households favour other avenues for deploying their savings instead of banks.
• Merger of HDFC Ltd (HFC) with HDFC Bank: The merged HFC had a low deposit base and was primarily dependent on market borrowings as a source of funds. Consequently, the merger did not impact the deposit base much, but it increased the loans and advances of the banking system. Post the merger, HDFC bank's CD ratio touched 104% by March-end 2024, and SCBs outstanding credit growth increased by ~4.0 percentage points. On the other hand, the deposit growth increased by just 0.6%. This has further widened the credit-deposit gap.

Public Sector Banks Vs Private Sector Banks

The CD ratio of Private Sector Banks (PVBs) has been particularly high compared to Public Sector Banks (PSBs). PSBs CD ratio has remained lower than all SCBs level, while that of PVBs remained consistently higher since FY2012. According to RBI’s Financial Stability Report - June 2024, out of 33 banks (PSBs and PVBs), around 25 banks with CD ratios above 75% are PVBs. 

Why PVB’s CD ratio is higher than PSBs? 

• Aggressive lending strategies: PVBs are generally more willing to take calculated risks in lending, and tend to be more oriented towards unsecured personal loans, credit cards, and retail lending,  as they can charge higher interest rates to these lendings. While PSBs have more conservative lending approaches.
• Focus on high-growth sectors: Growing sectors of the economy, such as consumer finance, Small and Medium Enterprises (SMEs), and emerging industries are the most preferred ones for PVBs lending. While PSBs are more towards agriculture and industrial credit due to mandatory priority sector lending.
• Efficient fund management practices: PVBs maintain a higher Capital-to-Risk-weighted Assets Ratio (CRAR) compared to PSBs, which allows them to support higher levels of lending relative to their deposit base. For example, as per RBI’s FSR - June 2024, the PVBs CRAR stood higher at 17.8% compared to PSBs 15.5%, and all SCBs (16.8%) as of March 2024. PSBs also have a higher proportion of low-cost deposits.

Rural vs Urban Banking

The CD ratio varies significantly between rural, semi-urban, urban and metropolitan banks, according to RBI data.

• The greater demand for credit in cities is reflected in the CD ratio of semi-urban and metropolitan banks compared to rural banks which remained relatively low.
• In FY2024, the share of metropolitan centres in total credit disbursement stood at around 57%.
• In terms of deposit mobilisation, the share of metropolitan centres slightly varied at 53% in FY2024.
• The share of non-metropolitan centres (Urban (19%), semi-urban (14%) and rural (9%)), in the total bank credit, is disproportionately lower than their respective shares in the total bank deposits (Urban (21%), semi-urban (16%) and rural (10%)).
• Rural banks often struggle with lower CD ratios due to limited lending opportunities. They also face challenges in maintaining liquidity due to seasonal fluctuations in cash flows, limited access to diverse funding sources and higher operational costs.

Interest Rates, Deposit and Credit Growth

Since 2022, India has witnessed an interesting economic scenario. The economic recovery gained momentum creating huge demand for credit in the economy, while inflation surged and remained above the RBI’s tolerance limits for most part of the year. To suppress inflation, the RBI changed course on interest rates and resorted to successive repo rate hikes beginning May 2022. By February 2023, the RBI raised the repo rate by a cumulative 250 basis points and maintained it at 6.5% since then. Accordingly, banks also increased the lending and borrowing rates. Despite the higher interest rates, the deposit growth failed to keep pace with credit growth, resulting in a rise in the CD ratio. This mismatch prompted the banks to increase their deposit rates further, even though the broader economic environment suggests potential interest rate cuts by RBI in the near term to support growth. This unique situation likely has multiple implications for the bank's profitability and poses unique challenges to the banking sector's stability. 

Note: Rates are based on the weighted average domestic term deposit rates (WADTDR) of SCBs and weighted average lending rates (WALR) of SCBs on fresh rupee loans, published by the RBI.

Implications of High CD Ratio 

On Banks:

• This may potentially expose the banking system to structural liquidity issues
• Pressure on banks to increase  interest rates to attract deposits
• Challenges in maintaining regulatory capital requirements and adequate liquidity buffers

On Bank Loans: 

• More stringent loan approval criteria
• Higher interest rates on loans to reduce demand for credit or to match with higher deposit rate
• Increased focus on high-quality borrowers and a low-risk appetite 

On Depositors:

• A high CD ratio may lead to higher deposit rates to attract more funds

Implications of Low CD Ratio 

On Banks:

• More aggressive lending practices with higher risk appetite
• Competitive interest rates to attract more deposits
• Easier access to credit for borrowers 

On Depositors:

• A low CD ratio could result in lower deposit rates due to excess liquidity

Strategies for Managing Healthy CD Ratio

Recently, RBI Governor Shaktikanta Das stated, “We are closely monitoring the credit-deposit ratio trends and will take appropriate measures to ensure banking sector stability”. To maintain a healthy CD ratio and to ensure long-term banking stability, balancing deposit growth with credit expansion is crucial. Banks can employ several strategies to manage high credit deposit ratios such as:

• Diversify funding sources (e.g. bonds, securitisation)
• Implement stricter lending criteria
• Optimise asset-liability management
• Enhance risk assessment and monitoring systems
• Focus on deposit mobilisation through innovative products

To mobilise deposits, SBI has launched products like: 

• SBI Green Rupee Term Deposit, which aims to mobilise deposits for financing green initiatives;
• SBI We Care Deposit scheme with higher interest rates extended to senior citizens; and
• Sarvottam (Non-Callable Deposit) Term Deposit scheme with higher interest rates for 1-year and 2-year deposits.

Conclusion

Credit demand in the economy remained strong in the past two years, prompting banks to gather substantial deposits to address this demand. Nevertheless, these efforts were insufficient to satisfy the high credit demand, resulting in a continuous increase in the CD ratio. The elevated CD ratio of certain banks could potentially pose credit or liquidity challenges. Although the RBI has raised concerns, it considers the current CD ratio levels to be manageable given the overall health of the banking system. Hence, to avoid any risks in the future and to maintain banking stability, the RBI may implement measures such as:

• Increase scrutiny of banks with high CD ratios
• Guidelines for maintaining adequate liquidity buffers
• Stress testing requirements for banks to assess liquidity risks