Indian banks do have a deposit problem

The RBI has expressed concern about deposit growth lagging credit growth and acting as a constraint on faster growth of credit. One reason, it says, this has happened is because savers, especially young savers, are today more attracted towards alternatives to deposits such as mutual funds and insurance.

Some commentators have said there is no such problem because, first,  invetments in mutual funds and insurance also come back eventually to the banking system as deposits and, secondly, because loans create deposits anyway. They say that if deposits are growing slowly it is because money supply is not growing fast enough.Let the RBI cut interest rates and that will turn on the deposit tap.

I examine these propositions and the fallacies therein in my BS article, RBI's push for deposit growth. 

Deposits can be retail or wholesale, they can be current account, saving or fixed deposits. Which of these a bank uses for funding loans has implications for its stability. The RBI's exhortations, I argued, are about growing granual retail deposits as distinct from lumpy, wholesale deposits. Not having enough retail deposits to back loans can create serious issues for banks.

FINGER ON THE PULSE

T T Ram Mohan

RBI’s concerns on deposit growth are valid

The 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. 

A bank can make a loan through an entry in the ledger. The bank then makes a matching entry for deposits on the liability side of its balance sheet. So, yes, the bank can conjure up loans and deposits out of thin air.

However, when the borrower issues a cheque against the loan in order to make a payment, the deposit will need to be backed by funds. For its immediate needs, the bank can borrow funds from the central bank or in the inter-bank market.  

There are limits, regulatory and prudential, to such borrowings. To safeguard its stability, the bank will have to go to the ultimate savers and garner deposits, instead of accessing funds from intermediaries. Again, how loans are funded is material. 

            iii.     Deposit growth is linked to the creation of money by the central bank. It is no use blaming banks for the slow growth of deposits if the central bank is not creating enough money in the first place. 

Money supply is equal to base money (bank reserves plus currency) times the money multiplier. If the central bank wishes to increase the money supply, it can buy bonds from banks through open market operations (OMO), so that bank reserves rise. 

Money supply is also equal to currency plus deposits. When the money supply goes up, deposits on the other side of the equation rise correspondingly. Combining the two equations above, if deposits are not rising fast enough, it is contended, is because the central bank is not creating enough money. 

There are two fallacies in this line of argument. First, central banks cannot be doing OMO and increasing bank reserves just to increase deposits- OMO is done to meet the interest rate target at any point in time.  

Second, we need to be clear about how exactly an increase in reserves contributes to an increase in deposits. When banks have excess reserves, loans can grow faster than otherwise. Incremental loans will be matched by entries of incremental deposits in banks’ balance sheets. So, yes, we will see deposits rise as  money supply expands. 

However, if liquidity and interest rate risks are to be properly managed, incremental deposit entries will have to be backed by stable funds in the form of deposits. 

So much for the criticisms of the RBI governor’s remarks. 

Now to the point about the importance of the type of deposit a bank sources for funding loans..  Deposits can happen through current accounts, saving  accounts, and fixed (or term) deposits (FDs). 

Current accounts carry zero interest and hence are free from interest rate risk. However, as mentioned earlier, current account deposits pose high liquidity risks for banks.  Saving deposits, unlike current accounts, carry an interest cost. The interest rate on saving  deposits is supposed to be considerably lower than on FDs and it fluctuates in a narrow range, so the interest rate risk is also low. If saving  deposits are retail in nature, they are considered highly stable, that is, they pose low liquidity risk.

FDs carry a higher interest rate than both current and savings deposits, but retail FDs are relatively stable compared to corporate FDs (which are typically of shorter maturity). From the point of view of managing liquidity risk, deposits below ~2 crore are considered a preferable form of retail deposits, followed by those below ~5 crore. The exhortations to banks to grow deposits, it must be understood, are about growing retail deposits as distinct from large value wholesale deposits.

That is turning out to be a challenge for many banks. Banks lulled themselves into thinking that they could access retail deposits at a lower cost through online banking and under-invested in their branch networks. They have since woken up to the centrality of the branch network when it comes to accessing deposits. Public sector banks have the legacy of a large network of branches. But they need to rejig their branches, given the rise of new deposit growth centres in the country.

Many private banks offer interest rates close to those of FDs on all savings deposits above a certain minimum. This is a travesty of the concept of saving deposits. Saving  deposits are supposed to offer a low interest rate as banks provide a payment service against them. Because depositors are okay with a low interest rate, saving  deposits will not flee with interest rate changes. 

These features cease to apply if depositors are offered FD-like interest rates on savings deposits. The RBI must mandate that only deposits with an interest rate of up to, say, 150 basis points above the SBI’s savings deposit rate can be categorised as a “saving” deposit. 

Banks have also shot themselves in the foot by over-selling mutual fund and insurance products in order to boost fee income. Little did they realise that this would exact a cost in terms of excessive dependence on bulk deposits to drive loan growth. 

Banks need to remind themselves that loans also bring valuable fee income. They must think through the role of fee-based products such as mutual funds and insurance in the overall scheme of things. The mantra for banking stability remains unchanged: A bank’s focus must be on the core business of getting retail deposits and making loans. 

 

Silicon Valley CEO's high praise for IIT Madras

 Vivek Wadhwa, a successful Silicon Valley entrepreneur, has high praise for IIT Madras in this article:

When I visited IIT Madras earlier this year, I was blown away by the talent, world-class facilities, and their ability to connect with top scientists across India. I was so impressed that I decided to outsource the development of breakthrough technologies for my company, Vionix Biosciences, to them. Frankly, I told my friends and VCs in Silicon Valley where I live, that IIT Madras puts MIT, Duke, Stanford - and the Valley itself - to shame in terms of intellectual capacity, scale, ambition and  readiness to collaborate.

I've been more than amazed by the progress IIT Madras has already made in building technologies that could never be built in the West. The last company that tried to develop what we're doing was Theranos, which burned through $1.4 bn on medical diagnostics that are nowhere near the advanced solutions IIT has already created - at a tiny fraction of the cost.

Wadhwa goes on to make suggestions about the sort of research that Indian educational institutions must focus on:

India must avoid the pitfalls of the US research system, which, despite vast investments in basic research, is often disconnected from real-world applications. The US spends over $130 bn annually on academic research. Yet, much of it remains locked in the 'Valley of Death', where promising research never transitions into marketable solutions. As former dean of engineering at Duke University, Tom Katsouleas had told me, based on his work with the US National Academy of Engineering, 'Only about 1% of university patents are ever commercialised.'

I do not know how IIT Madras evaluates faculty. Do commercial applications carry as much weight in tenure and promotion decisions as publications in journals? If they do, then IIT Madras will find it difficult to improve its ranking in international ratings of institutions of higher education.

But then if research publications alone matter, institutions such as IIT Madras may lose out on applications. Wherein lies the balance between pure research and impact on practice? The answer has implications not just for IITs but also the IIMs and other places. 

Should the IIMs be trying to influence  practice through executive training, consulting and participation in policy-making by using the available research? Or should they try to catch up on research with the top institutions of the world, an objective that will remain elusive in the foreseeable future?

 

Is Warren Buffett's performance faltering?

That is what this article in the Economist suggests- and it is not the only one.

Berkshire Hathaway, the firm with which Warren Buffett has been famously identified, has underperformed the S&P 500 in the period 2009-23- the firm has produced an average return of 13 per cent per annum compared to the benchmark's 15 per cent. In the period since 2015, it has produced a total return of 155 per cent compared to the benchmark's 164 per cent, as another article points out.  

Before we start dumping on the fabled Sage of Omaha, it is appropriate to place the firm's underperformance in context as the second article cited above does:

The conglomerate's stock has reached a fresh all-time high in 2024, suggesting that, despite the underperformance relative to the S&P 500 since 2015, the company remains a formidable force in the investment world. Furthermore, Buffett's track record since the 1960s, with average annual returns around 20%, speaks to a legacy of success that few can match. The question of whether Warren Buffett has lost his touch is not new; it has arisen periodically throughout his career, only for Buffett and Berkshire Hathaway to emerge stronger.

The Economist article delves into the reasons why performance has been lacklustre in recent years. Size is part of the problem. On a bigger size, sustaining returns is difficult. But then firms such as Apple and Microsoft that are even bigger have managed to do so. An important reason is that the firm is invested in old economy firms and it appears reluctant to bring technological innovation into those, such as using software to let less risky drivers pay lower premiums in its insurance business. 

Mr Buffett chastises boards and management on various counts but his own corporate governance is little to write home about: his firm discloses the bare minimum, has an aged board and does not have an email address or phone number to which questions can be addressed. When you are performing, nobody bothers. When you don't, people start looking closely at these things.

On a different note, Buffett has often been cited as evidence that a forecast of the efficient market hypothesis is incorrect- he is one manager who has outsmarted the index over several decades. I had a post earlier on how Eugene Fama, the father of the hypothesis, still swears by it.

How would Fama explain a phenomenon such as Buffett and Berkshire Hathaway? Fama has said that Buffett is not just an investor. He is somebody who takes over under-performing businesses and runs them. To see whether the efficient market hypothesis holds for entrepreneurs, Fama says he would have take a large cross-section of businesses and evaluate performance- and there isn't that sort of data. 

Fama sees Buffett as picking up individual businesses every few years and improving their returns. When it comes to running a portfolio, Fama says, Buffett himself has recommended that his wife put her money in an index fund! 

Says Fama, "Buffett is my hero". Shows it's hard to get members of the Chicago school to change their minds. 

Maharashtra government offers third option to employees- Revised Pension Scheme!

We had the New Pension Scheme (NPS) in operation since 2004. Before that, we had the Old Pension Scheme (OPS). The central government recently announced Unified Pension Scheme (UPS). The Maharashtra government was quick to announce its acceptance of UPS, giving employees a choice between UPS and NPS. It has since announced a third option, Revised Pension Plan (RPS)!

What's the difference? First, about UPS. Most people think that it's very similar to OPS except that employees have to contribute 10 per cent of their salary whereas OPS required no contribution. Former finance secretary Subhash Chandra Garg has highlighted an important difference. (I too had picked it up but I thought I was wrong). If Garg is wrong, please let me know. 

The UPS, Garg says, assures 50 per cent of the basic pay of the last 12 months of an employee. This will be indexed to inflation. The OPS assured 50 per cent of basic pay plus DA. So the pension amount is not quite the same.  (We do not know whether UPS will be revised with new Pay Commission recommendations as is the case with OPS). However, 50 per cent of basic pay would be an improvement on what most employees have been getting by way of cumulative amount through investment in NPS. 

Now, about RPS. The RPS offered by the Maharashtra government is 50 per cent of the last drawn salary (I presume, again it's the last drawn basic pay). Then, it's clearly superior to UPS? Not quite because the UPS also offers a lump sum amount which, I believe, the RPS does not. For those promoted towards the end, RPS may be better. For others, UPS would seem better.

Garg says it's only a matter of time before government employees begin to clamour for OPS. As the ranks of the government employees post 2004 grows, the clamour will become very difficult to resist. 

Concentration in the Economics profession

Top researchers in Economics are concentrated in just 8 institutions in the US, an NBER study finds. The study gathered data on the educational and professional affiliations of 6000 award winners of 170 notable winners in three broad areas: natural sciences, enginnering and social sciences. Each of these three areas was broken up into six fields each, giving a total of 18 key fields.

All fields show a declining level of concentration, except Economics which is a clear outlier. Economics shows a high and ascending concentration over time. This is visible in the most notable of awards, the Nobel prize where again Economics shows high concentration whereas chemistry, physics and medicine show low concentration.

The authors examine the reasons why this is so. They hypthesise that three factors are relevant: the dependence on physical equipment, the development stage of a field and the role of prestige. In Economics, physical equipment is not important so researchers are highly mobile, it is a relatively new field and prestige plays a more important role in Economics than in other fields. 

How exactly does prestige matter? Well, the more famous economists receive more citations than academics in other fields. Institutional prestige can be measured by the ranking  of an institution. The top institutions in Economics remained at the top more than in other fields. Consequently, the best names tended to gravitate towards the top institutions, making for more concentration of talent.

Why should we be concerned? The economists at the top institutions control, in a way, publications in the top journals. This means that only ideas that they are comfortable with may get through. In other words, concentration in Economics may mean a monopoly over ideas. New, original and heretical ideas may not find adequate expression. That is bad for the advancement of knowledge.

The more difficult question, which the paper does not address, is: how do we prevent rising concentration in Economics? Part of the answer may be for the non-elite institutions to accept publications in journals other than the top ones for evaluation and tenure. A group of faculty of high calibre, whether from within an institution or from outside, may judge the quality of publications that have not made it to the top three or four publications and give ratings. Institutions may give extra weights to ideas that are outside the mainstream. If the stranglehold over ideas of the top journals wanes, so could the strangehold of the top economists and the institutions they belong to.

Institutions may also give a little more weight for the application of ideas or the impact on practice of academics. Where academics significantly influence policy-making, credit can be given for the purpose of granting tenure. One way or another, it is important that a few institutions do not arrogate to themselves the role of gate-keepers of ideas in Economics.