RBI's deposit growth concerns are valid

The central bank's exhortations to grow deposits are about growing retail deposits

- RAM MOHAN

The Reserve Bank of India (RBI) governor has urged banks to increase deposit growth. The governor's exhortations have been met with criticism and even ridicule from some commentators.

Some analysts contend that the deposit problem is entirely imaginary and that banks do not face any deposit constraint in the matter of making loans. They are wrong. The RBI governor's concerns are well-founded, as a hard look at the critics' propositions will make clear.

i. Savers, especially young savers, are turning to alternatives to deposits such as mutual fund and insurance products. That should not worry banks because what is parked with mutual funds and insurance companies returns to the banking system as deposits. It is true that money invested in mutual funds and insurance products must come back to the banking system. However, when savers invest in banks, they choose saving or fixed deposits with relatively long maturity. The amounts they invest in mutual funds and insurance companies return to the banking system as current account deposits or fixed deposits of very short maturity. The latter are less stable than saving deposits. As a result, banks are constrained in the loans they can finance with current account or short-term fixed deposits. More on the importance of the type of deposit later. ii. Loans create deposits, not vice versa. So the idea that deposits can constrain loan growth is plain wrong.

That loans create deposits is one of the more famous propositions of Modern Monetary Theory (MMT). Its meaning must not be misconstrued.