There is good news for those who believe in FDs as a critical foundation in their investment portfolio.

Bank fixed deposit (FD) interest rates have risen to 9.5%, the financial domain sees a significant shift, especially among senior citizens who now hold 47% of all FDs and there is a call that perhaps in light of these findings, the taxation regime should be changed.

Recently, Finance Minister Nirmala Sitharaman and Reserve Bank of India (RBI) Governor Shaktikanta Das directed the banks to boost their deposit base substantially.

Although banks’ financial health appears stable, with both secured and unsecured lending increasing due to strong corporate and individual demand for capital, credit growth has consistently outpaced deposit growth in recent quarters.

This disparity became increasingly concerning for RBI Governor Das.
In fact, in a recent speech, Das stressed the importance for banks to “prioritize mobilizing household financial savings through innovative products and services, and by fully utilizing their extensive branch networks.”

As individuals continue to find better returns in equities, real estate, gold, and alternative investments, banks are struggling to attract deposits, despite loan growth trailing behind.

At the same time, the RBI has reiterated its strict stance on compliance and regulatory lapses to bank leaders, emphasizing the need for clear income recognition, managing bad loans, and provisioning—especially in light of the aggressive lending trends of recent years.

“The disparity between bank deposit growth and credit growth could lead to liquidity management challenges for banks,” Das warned in a recent meeting after announcing the decision to maintain interest rates at 6.5 percent, following the last rate hike in February 2023.

Still, while experts acknowledge that banks could potentially face liquidity issues if the credit-to-deposit gap widens, this situation does not currently appear to be a widespread concern for most Indian banks.

“The real issue occurs when a bank raises short-term deposits to finance a long-term asset, and those deposits aren’t renewed. In such cases, the bank must find funds to cover those deposits,” explains a banking analyst from a private research firm, who requested anonymity. However, this isn’t a major concern for India’s large and mid-sized banks.

Soaring FD Rates

With the bank FD rates now soaring to 9.5%, and largely held by senior citizens has prompted a critical evaluation of the taxation framework on fixed deposits.

While higher interest rates are attracting more deposits, particularly in term deposits, the overall dynamics of deposit growth remain complex.

Hence, despite concerns about lagging deposit growth, recent data reveals a different story, bringing forth the intricate factors influencing deposit trends in the banking sector.

The Critical Question Of Deposit Growth

According to an SBI Research report dated August 19, 2024, the banking sector has experienced deposit growth of Rs 61 trillion since FY22, surpassing credit growth, which stands at Rs 59 trillion.

The report challenges the perception of declining deposit growth, stating,

“The myth of flagging deposit growth does not hold up under data scrutiny… CASA deposits are influenced by UPI transactions, leading to movement across the banking system. Factors such as the growth in Reserve Money, leakages from the banking system, and regulatory measures may be contributing to slower deposit growth. It’s essential to ensure fair taxation on interest from deposits.”

Decline in CASA
The banking system is also witnessing a decline in CASA deposits, which dropped to 41.0% in FY24 from 43.5% in FY23, with savings bank (SB) deposits decreasing to levels similar to the pre-pandemic rate of 42%.

As SB accounts are increasingly used for transactions, particularly through UPI, the stability of SB deposits has become a concern as they frequently move across the banking system.

Bank FD Interest Rates
The rising interest rates on term deposits have led to a shift in the composition of bank deposits, with the share of term deposits increasing to 59.0% of total deposits in FY24, up from 56.5% in FY23.

Incremental term deposits accounted for nearly 78% of total deposits in FY24, while CASA deposits declined; the shift is expected in a rising interest rate environment, where CASA deposits typically move to time deposits.

Average Ticket Size of FDs
Public Sector Banks (PSBs) have been particularly effective in mobilizing low-ticket deposits across the banking spectrum.

The average ticket size of SB/Term deposits at PSBs is Rs 72,577, compared to Rs 1.60 lakhs at Private Sector Banks and Rs 10.5 lakhs at Foreign Banks.

PSBs are also more active in rural and semi-urban regions, contributing to a significant increase in deposits from women, driven by the strengthening of Self-Help Group (SHG) linkages across the banking sector.

So now the question is, who is Investing in Bank FDs?

While bank deposits are favored for their safety and liquidity, they fall short in terms of returns.

Interestingly, 47% of term deposits are now held by senior citizens, indicating that younger generations are increasingly turning away from traditional investments like bank deposits.

In contrast, the median age of all investors in the capital markets is now 32 years, with approximately 40% of investors being under 30.

Thus, the trend suggests a shift toward mutual funds and equities among younger investors.

Given this shift, there is a strong case for the government to reconsider the taxation of interest on bank deposits, particularly by delinking it from the highest income tax bracket and taxing it at redemption rather than on an accrual basis.

Taxation of Bank FDs
To understand how taxation affects bank deposits – an analysis of the annual data on per-capita income (PCI) and deposits from 1970-71 to 2023-24, was done using individual income tax as a control variable.

The results show that for every Rs 1000 increase in per-capita income, deposits increase by Rs 613 when tax is considered as a control variable. Without the tax, deposits could have increased by Rs 652, indicating that taxes reduce bank deposits by about 7%.

This analysis strengthens the argument for treating bank deposits as a distinct asset class with uniform tax treatment.

The simulations suggest that applying a uniform tax treatment, similar to that of short- and long-term capital gains, would have a minimal impact on government revenues.

The Last Bit, The recent surge in bank fixed deposit FD interest rates to 9.5% is a good step to lure in more investments in FDs particularly for senior citizens, who now hold nearly half of all term deposits.

Thus there is a growing segment that thinks that there should be a reevaluation of the taxation policies on bank deposits, as younger investors gravitate towards higher-return options like mutual funds and equities, with the median age of capital market investors now at 32 years.

Despite concerns about slowing deposit growth, recent data from SBI Research reveals that deposit growth has actually outpaced credit growth, reaching Rs 61 trillion since FY22.

However, the composition of deposits is shifting, with a decline in CASA deposits and a rising share of term deposits, driven by the higher interest rates.

The analysis also shows the impact of taxation on deposit growth, indicating that taxes reduce deposits by about 7%.

Given these dynamics, there is a strong case for the government to reconsider the tax treatment of bank deposits.

Proposals include delinking deposit interest from the highest income tax bracket and taxing it at redemption rather than on an accrual basis.

A uniform tax treatment similar to that of short- and long-term capital gains could help sustain the attractiveness of bank deposits as a stable investment option, especially as younger generations increasingly seek alternatives.