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Banks & Term Deposits - Are Retail Term Deposits losing sheen?

 

by

 

NSN Reddy, Chief Manager, Andhra Bank)

Gross Domestic Savings (GDS) play a vital role in the economic development of a country as it provides the requisite financial resources to undertake developmental activities. A high level of savings helps the economy to progress on a continuous growth path since investment is mainly financed out of savings. Absence of required Savings rate may lead to external dependence, which may jeopardize the interests of the Nation.

Gross Domestic Savings vis--vis Household Savings:

Savings habit is an in-built culture of the Indian system and the Savings rate of our Country has been one of the highest globally. The Savings rate had improved considerably from 23.70% in 2001 to 32.50% in 2009, with the Household sectors contribution to the Gross Domestic Savings being significant at 70%, followed by the Government and Corporate sectors.

Though, the Savings rate was impressive over the years, the capital formation had been relatively low as a lions share of the savings i.e. around 54% was being parked in physical assets such as Gold, Real Estate etc., and only 46% of savings moved into financial assets, which broadly include currency, deposits, equity, net claims on Government and others (insurance, pension, provident funds etc.). Over the years, the trend indicates that the Household sector gradually moved from physical assets to financial assets.

Financial Assets - Role of Bank Deposits:

Historically, Bank deposits seemed to be the preferred choice of individuals mainly on account of its inbuilt features such as Safety, Security and Liquidity. Out of the total financial assets, the share of bank deposits improved from 8.10% in the early seventies to 16.30% in the late nineties and is now around 28.30%.  Despite volatile interest rates (ranging from 5.75% to 12% during 1997 to 2005) term deposits have shown a consistent growth over the years on account of its embedded features of reasonable assured returns coupled with absence of other financial investment avenues to the retail investors.

Ownership of Deposits Trends:

The major sources for bank deposits can be broadly categorized in to five segments viz., Government, Corporates, Finance sector, Households (Individuals/Trusts/Sole Prop.) and Foreign sector (NRIs). Traditionally, the Household sector has been playing a leading role followed by the Government sector. However, the trend has undergone a change during the last one decade as is evident from the following table.

 

Ownership of Deposits (%)

No

Category

1990

2001

2009

Var. over 1990

1

Government

6.80

10.00

14.00

+7.20

2

Corporate (Private)

6.20

4.60

14.50

+8.30

3

Financial sector

6.20

7.30

8.90

+2.70

4

Household (Ind./Trusts/Prop.)

71.60

67.20

58.30

-13.30

5

Foreign sector

9.20

10.90

4.30

-4.90

Source: RBI Reports

Significant shift in ownership of deposits was seen in the last two decades.  The share of Government and Corporate sectors increased by 7.20% & 8.30% respectively while the share of Household came down by 13.30% during the said period.

Increased budgetary allocations for developmental/welfare measures coupled with phased manner deployment may be the prime reason for improved market share of Government deposits in Banks.

Post liberalisation era has witnessed a steep growth in the number of corporates in production and service sectors. Hitherto, corporates used to keep the balances in current accounts to meet their requirements. Of late, the adoption of prudent financial management practices by the corporates i.e. converting surplus balances in to short term deposits / Certificate of Deposits, enabled them to earn higher interest income. Perhaps, this could be one of the major contributing factors for the increased share of corporates in bank deposits.

Reduction of Household share and increase of corporate share in total deposits is an interesting phenomenon, which calls for in depth analysis as it is an indication for skewed distribution of income across the various segments.

Despite considerable shift in ownership of deposits, the Household sector continues to be the leader with a market share of 58.30%, which speaks of the importance of this segment in resource mobilization.

Deposit Mix:

The Bank deposits are broadly classified in to three categories viz., Current, Savings and Term Deposits. Normally, Current Deposits are meant for Government, Corporate, Institutions and Business segments where as Savings Deposits are designed for individuals. Term Deposits are targeted predominantly for the Household segment and institutions.

Scheduled Commercial Banks Deposit Mix

Category

2001

2009

Current Deposits

12.70%

12.00%

Savings Deposits

23.80%

23.30%

Term Deposits

63.50%

64.70%

Source: RBI Reports

 

Though, there was considerable shift in the market share of Government/Corporates during the last two decades, the deposit mix remained the same even in the liberalized environment which demonstrates the importance of term deposits.  However, some interesting observations can be drawn from the following table.

Ownership of Deposits Deposit Mix - March 2009 (%)

No

Category

Current

Savings

Term

1

Government

17.60

9.10

15.10

2

Private corporates

27.50

0.40

17.20

3

Financial sector

9.10

0.80

11.70

4

Household

43.70

75.70

51.90

 

i) Individuals

17.50

75.50

41.30

 

ii) Trusts / Prop.

26.20

0.20

10.60

5

Foreign sector

2.10

6.00

4.10

 

Total

100.00

100

100

Source: RBI Monthly Bulletin January 2011

 

      Contrary to the common belief that the Government and Corporates keep their surplus funds in current accounts, it is observed that they are parking funds in Term Deposits. Whilst the share of Government/Corporates/Institutes to total term deposits which stood at 44%, shows their prudent management of funds, in the process, the banks are deprived of free float funds thereby bearing an impact on the Net Interest Margin (NIM).

 

      The contribution of Individuals to the Savings as well as Term Deposits was significant with a share of 75.5% & 41.30% respectively.

 

Deposit Mix - Average Annual Growth Rates (%)

Period

Current
Deposits

Savings Bank
Deposits

Term Deposits

Aggregate Deposits

1981 to 1990

20.5

17.1

20.8

18.9

1991 to 2000

12.5

15.7

17.4

16.1

2001 to 2010

16.2

20.4

18.2

18.2

(a) 2000 to 05

12.8

18.8

14.8

15.4

(b) 2005 to 10

20.7

20.1

21.7

21.0

Source : RBI - Discussion paper on Deregulation of SB Interest Rate

 

Term Deposits have been growing at a reasonable rate of 21.70% even in the downward interest rate regime (2005 to 2010).

 

In the above backdrop, an attempt is made to analyse the composition of term deposits to ascertain growth trends across the various ownership groups.

 

 

Composition of Term Deposits:

At present, the term deposits include Retail, Bulk and Certificate of Deposit (CD). CDs are like bank term deposits but unlike traditional fixed deposits these are freely negotiable. Banks are allowed to issue CDs with maturities of 7 days to one year in denominations of `1 lac and multiples of `1 lac thereafter. This product has attained greater investor demand as they are flexible and tradable instruments with higher interest rate compared to other term deposits. Despite the fact that CDs are expensive, banks continued to focus attention on this segment as banks found it a tool to surge over tight liquidity situations, especially to meet credit demand.

Based on the available data on Certificate of Deposits, the term deposit component is reworked and the growth rate is arrived as under:

Year Aggregate Deposits (Crore)

Term Deposits (Crore)

Certificate of Dep.$

Retail Term Dep.

%of CDs to total Deposits

Amount (Crore)

Growth Rate (%)

Amount (Crore)

Growth Rate (%)

2006

2164682

1328862

38568

-

1290294

-

1.78

2007

2696937

1710389

93808

143.23

1616581

25.29

3.48

2008

3320062

2133954

149986

59.89

1983968

22.73

4.52

2009

4063201

2716084

198497

32.34

2517587

26.90

4.89

2010

4752456

3071522

341830

72.21

2729692

8.42

7.19

2011

5355160

3369556*

444525

30.04

2925031

7.16

8.30

Source: RBI Monthly Bulletins      * estimated figure taking the previous year term deposit mix.

$CDs outstanding as on first reporting Friday of April

The issuance of CDs has gained momentum in the recent years as there has been increased demand for retail / infrastructure credit. It is pertinent to note that banks are concentrating more on mobilization of high cost wholesale funds (CDs) instead of paying attention  to retail deposits which are relatively stable and cost effective.

The outstanding balance under CDs increased from `38568 crore in 2006 to `444525 crore in 2011 and this portfolio is growing at a galloping speed. Today, the share of CDs to total deposits   indicates an increasing trend, constituting around 8.30% of the aggregate deposits of the banks. High dependence on institutional funding could significantly impact the Net Interest Margins (NIMs) besides leading to ROA volatility.

Though, absolute increase is seen in term deposits, the growth rate of retail segment appears not very encouraging as the growth rate has come down from 25.29% in 2007 to 7.16% in 2011. While retail growth rate is in single digit, the CDs growth rate is in double digit.

 

 

 

 

 

 

Retail Term Deposits Recent trends:

 

The individuals contribute a significant share in the resource mobilization of banks since normally they prefer to keep their surplus funds with the banks to meet their immediate as well as medium and long term commitments.

 

Banks fixed deposits is one of the most preferred common savings scheme as it carries   a relatively higher rate of interest when compared to  the savings bank deposit, besides providing safety, security and convenience to the depositor.  The following features have made the bank fixed deposits more attractive:

 

      Deposits held with banks are secured by Deposit Insurance and Credit Guarantee Corporation (DICGC) up to one lakh per account and thereby the default risk is protected.  

 

      Senior Citizens are eligible to avail extra interest by 0.50% over and above the normal interest rate.

 

      1% penalty for premature closure of Term Deposits of `1 lakh & below is waived.

 

      Banks are allowed to issue Tax Saver term deposits with five years tenor to the individual depositors up to a maximum of `1 lakh. These deposits are eligible for tax exemption under section 80C of IT Act. Unlike normal deposits these deposits cannot be withdrawn, transferred or pledged.

 

      Exempted categories of individuals such as farmers etc., are exempted from TDS on interest income from bank fixed deposits subject to furnishing Form 15G every year.

 

      Similarly, for Senior citizens whose income is below the taxable limit, which is currently `2.40 lakh, the interest income on their fixed deposits is exempted from TDS subject to furnishing of Form 15H to the bank every year.

 

      Core Banking has enabled the banks to extend flexi deposit products, which offers the features of Savings (flexible operations) as well as term deposits (higher interest rate). The depositor can operate the account like a normal savings bank account and continue to earn relatively higher interest for the balance available in the account.

Notwithstanding the availability of various embedded features, the retail term deposits are still not growing to the desired level especially during the last few years, which needs a critical review by the Banks and Regulators.

In this context, the arguments that are doing the rounds are:

      Low interest rates or non competitive interest rates.

      Is it a fact that depositors are opting for other alternate instruments i.e. equity / mutual funds.

      Are the depositors moving towards physical assets instead of financial assets?

      Have the existing tax laws, impediment to the growth of retail term deposits?

The data pertaining to term deposit growth rate from 1981 to 2010 proves beyond doubt that term deposits have grown considerably even in the downward interest rate regime. Further, it is more interesting to note that the retail deposit growth has come down in the recent years (2010 & 2011) while interest rates are moving upward.

As per the latest reports, the participation of households in equity related investments stood around 3.80% of Gross Domestic Savings and no perceptible shift is observed over the years. Hence, the argument of moving over from bank deposits to other financial products (equity, mutual funds etc.,) may not hold good.

It may be true to some extent that the households prefer to invest in physical assets rather than financial assets in order to protect their investments from the effects of rising inflation. In the recent years, the demand for real estate, gold and silver has been increasing from this segment. This trend needs to be arrested as scarce funds are being diverted into unproductive segments.

Term Deposits Income Tax & Operational issues:

 

It is the time to examine the existing income tax laws and other associated operational issues which appear to be working as a disincentive to the individual depositors and also could be one of the reasons for slow growth of the retail term deposits.

 

      As per the prevailing laws, interest earned on fixed deposit is treated as Income from other sources for the purpose of taxation. Hence, banks are required to deduct TDS from all the accounts where the interest amount from the Bank deposits exceeds `10,000/- per branch.

 

      At present, such accounts attract TDS @ 10.30% (TDS 10% + 3% education cess on tax) and the same is to be deducted before crediting the interest amount to the account.

 

      With effect from 1st April 2010, the TDS rate has been increased to 20% for individuals who fail to furnish PAN proof. Majority of the rural/semi-urban depositors do not have PAN number and are also not aware of the implications, which is costing them heavily.

 

      Further, the exempted categories are required to submit 15G or 15H every year failing which the interest income is subjected to TDS, thereby causing concern to the individual depositors.

 

      Renewal of deposits is another area of concern to the depositors especially in the volatile interest rate environment (upward movement) as there is inordinate delay at branches in attending to the renewals of deposits for higher interest.

 

Issues requiring revision or improvement:

 

      There is every need to enhance the TDS threshold limit from the existing `10000/- to `20000/- in the light of the prevailing inflation environment.

 

      Submission of 15G or 15H at the time of opening of the account may be treated as submission for the entire tenor of the deposit.

 

      Furnishing PAN proof especially by the exempted categories may require re-examination as it is adversely affecting the depositors of rural/semi-urban who normally do not possess PAN.

 

      With regard to deposits made by the individuals having agricultural income, a declaration in form no.61 (IT act) can be obtained and submission of PAN dispensed with.

 

      Auto renewal of deposit is to be made mandatory to enable the depositors not lose interest for the intervening period.

 

      Whenever there is an upward revision of interest rates, a provision shall be made for automatic renewal of the existing deposits.

 

      Though, banks are offering Tax Saver scheme to the customers to avail tax exemption under section 80C of IT Act, majority of the eligible bank clientele are not aware of the product and thereby the product has not taken-off in most of the banks. There is an urgent need to improve the visibility of the product through proper advertisement. To make the product more attractive, the lock-in period may be reduced to 3 years from the existing 5 years.

 

      Recurring Deposits, the traditional term deposit product, is having a unique feature that the entire interest amount is exempted from TDS. It is the only domestic term deposit which enjoys tax exemptions. Despite having best features, Recurring Deposits could not reach the desired levels and is slowly fading on account of suboptimal attention paid by the banks in marketing the product to the target group.

 

Stable retail account base is the need of the hour for the banks to ensure mobilization of the required resources to meet the increased credit demand, duly protecting its NIM in the competitive environment. Let us hope and aim that banks achieve the desired results by increasing the Household share in term deposits as well as total deposits in the ensuing years.

 

 

***September,  2010***

*[Mr NSN Reddy, who is working as Chief Manager, in Andhra Bank has B,Com, CAIIB, PGDBM (NIBM) qualifications to his credit and has over 32 years of Banking experience]

Important Notice :  [The articles written by authors contains only the academic view of the writer and purely for discussions and updation of the knowledge of the bankers.   The views expressed in the articles may not at all be subscribed by the organisation where the author is working and / or AllBankingSolutions.com]