According to the latest data from the Reserve Bank of India (RBI), Indian banks are increasingly turning to Certificates of Deposit (CDs) to raise funds amid persistent liquidity constraints and challenges in mobilising traditional deposits. As of the fortnight ending February 7, 2025, the outstanding amount of CDs reached a record high of INR 5.19 trillion, reflecting banks' growing reliance on short-term borrowings to meet funding needs. This trend is set against a backdrop of credit growth consistently outpacing deposit growth. As of January 24, 2025, bank credit increased by 11.4 percent year-on-year to INR 178.7 trillion, while deposits grew by 10.3 percent to INR 221.3 trillion. This disparity has led to a significant uptick in the Credit-Deposit (CD) ratio, which rose by 41 basis points to 80.8 percent for the fortnight ending January 24, 2025.

Historically, Indian banks have maintained a comfortable liquidity position, with deposit growth often surpassing credit expansion. For instance, in March 2021, while credit disbursal grew by 5.6 percent, deposits increased by a more substantial 11.4 percent. This favourable balance ensured that banks had ample funds to meet lending demands. However, recent trends have reversed this scenario, raising concerns among policymakers. The Government and the Reserve Bank of India are particularly alarmed by the stagnation in deposit growth, coupled with accelerating credit demand. This mismatch poses challenges to banks' abilities to fulfil lending requirements.

How vital is the CD ratio?

A critical metric in this context is the Credit-Deposit (CD) ratio, which measures the proportion of deposited funds banks lend. A higher CD ratio indicates that a significant portion of deposits is being utilised for lending, suggesting potential liquidity constraints. Conversely, a lower ratio indicates that banks are not fully leveraging their deposit base for lending. Maintaining an optimal CD ratio is essential, as it reflects a bank's health and its capacity to cover loan losses and customer withdrawals. An excessively high ratio can signal increased risk and reduced liquidity, potentially leading to difficulties in meeting obligations.

On the other hand, a very low ratio may indicate underutilisation of available resources, suggesting that banks are not making full use of their funds for lending activities. Monetary policy plays a critical role in shaping the CD ratio, as economic and credit expansion are interconnected. The RBI regulates credit supply by adjusting reserve requirements, such as cash balances, statutory investments, and the cost of borrowing from the RBI. Economic reforms introduced in 1991 transformed monetary policy, phasing out ad hoc treasury bills, promoting a market for government securities, easing reserve constraints, and deregulating interest rates. These changes enhanced banks' ability to lend, thereby improving the CD ratio. Additionally, monetary policy is influenced by economic conditions, particularly inflation, which shapes the design of financial instruments. A stable CD ratio suggests that credit expansion is keeping pace with deposit growth.

The CD ratio is influenced by the volume of credit and deposits, which, in turn, depend on factors affecting the demand and supply of credit. Demand-side factors are often region- or sector-specific, whereas supply-side factors are shaped by policies governing resource allocation and the development of banking infrastructure. These factors have evolved over time. For example, during the 1970s and 1980s, the government’s control over the banking system boosted deposit mobilisation and directed credit programs to ensure the flow of credit aligned with social policy goals. However, following the introduction of reforms in the early 1990s, commercial banks prioritised meeting prudential requirements. This cautious approach resulted in a reduced CD ratio during this period compared to earlier decades.

Deposits, a crucial determinant of the CD ratio, depend on factors such as income levels, savings propensity, and the competitiveness of bank deposit rates relative to alternative investments like real estate, equities, or commodities. The availability of banking infrastructure, particularly in rural areas, also affects deposit mobilisation. External factors, such as economic conditions and investment opportunities, significantly influence bank deposit levels, which, in turn, affect the CD ratio. Ultimately, the growth of both credit and deposits is essential for the overall health of the banking sector. But what matters the most is raising the levels of both credit and deposits.

From 2005-06 onwards, the CD ratio exhibited an upward trend, reaching its peak between 2005 and 2013-14 during a credit boom driven by industrial credit growth. However, the period after 2013-14 saw a slowdown in industrial credit growth, offset by an acceleration in personal loans, particularly housing loans. Between 2006 and 2022, the average CD ratio remained above 75 percent, with minor fluctuations. Since 2011-12, both deposits and bank credit as a percentage of GDP have remained flat, indicating that credit growth has kept pace with deposit growth. However, the high CD ratio in recent years has coincided with slower economic growth; while the provision of bank credit has improved in relation to deposit mobilisation, the overall deposit base has contracted. This underscores the urgent need to enhance deposit mobilisation and channel more credit toward productive sectors.