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Indian banks are grappling with the worst deposit crisis in 20 years in fiscal year 2023-24. Banks have to struggle to attract deposits.  Credit growth being strong during this period. The extent of banks’ deposit crisis can be gauged from the credit to deposit ratio or CD ratio which has reached nearly a two-decade high. So, What is the CD ratio? Why is this ratio increasing? What are the implications of the CD ratio for banking shares? Should we buy or avoid banking shares currently?

According to RBI’s figures, the CD ratio or loan to deposit ratio of banks increased by 0.38% to 80.3% in fiscal year 2023-24, which is the highest level since 2005. The RBI started providing banks’ CD ratio from 2005 itself because there has been an increase in loan demand across all categories including home loans and other types of loans.

According to CareEdge Ratings, the HDFC merger is the major reason behind the rise in the CD ratio, as this ratio has remained around 80% since September 2023.  The CD ratio indicates how much of a bank’s deposit base is being utilized for lending.

Now let’s understand why the CD ratio is increasing and what is the situation for FY25? Experts believe that customers are investing money in equity-linked products where returns are better than banks. Keeping this in mind, banks raised deposit rates in FY24 to garner retail deposits. In fact, competition from peer banks and other investment options is increasing for banks. According to experts, a high CD ratio increases banks’ dependence on high-cost bulk deposits. This has also impacted banks’ NIMs or net interest margins. In Q3 FY24, HDFC Bank’s NIM remained flat at 3.4% on a quarterly basis. However, the market was expecting it to improve to 3.6%, because of this, the stock took a beating after the quarterly results.

Rating agency CareEdge believes that the CD ratio will remain above 81% in FY25 as well. This is because although credit growth may slow down a bit, it will still be higher than deposit growth rate.

Now let’s see what is the situation of credit growth?

In the fortnight ending March 22, credit offtake or loan disbursal grew by 20.2% year-on-year, which includes the impact of the HDFC merger. In the last 12 months, loan disbursal increased by Rs 27.6 lakh crore to Rs 164.3 lakh crore. The main reason behind the growth in loan disbursal is personal loans, whose demand has remained consistently strong. CareEdge Ratings believes that due to personal loans, the medium-term outlook for credit growth looks robust. Credit growth is expected to be around 14-14.5% by the end of FY25. However, the rating agency said there is a need to remain vigilant due to high interest rates and other uncertainties.

Now, what’s the situation of deposit growth?

Although there are signs of improvement in deposit growth, but, credit growth has remained higher in comparison. In FY24, including the impact of the HDFC twins merger, deposits grew by 13.5% year-on-year for banks. Even excluding the merger impact, deposit growth was 12.9% year-on-year. In the last 12 months, deposits grew by Rs 24.3 lakh crore, which is slower than loan disbursal. The rating agency expects deposit growth to be around 13-13.5% during FY25.

Now the most important question, what strategy should be made for banking shares in view of the rising CD ratio? Stock market expert Ambareesh Baliga believes that the rising CD ratio is a concern for the banking sector, because savers are now becoming investors. Moreover, Indian households’ liabilities are increasing, causing them to shift from “save & spend” to “borrow & spend”.

This could increase banks’ costs. And, there is a possibility of pressure on margins. But, some banks are in a better position. Among private banks, buy HDFC with a short-term target of Rs 1,750 and a long-term target of Rs 2,050. Among public banks, invest in SBI with a target of Rs 930 as its deposits are expected to increase.

Due to rising competition among banks to increase deposits and issues of high CD ratios, the battle between banks is likely to intensify further. In such a scenario, you can pick select private and public bank stocks by looking at valuation or price to book value multiple, NPA situation and NIM trends.