Pressure on PSBs as deposits decline, profitability faces strain

Public sector banks (PSBs) have enjoyed a phase of robust profitability, but challenges are brewing beneath the surface. A sharp decline in current and savings accounts (CASA) deposits — the most affordable source of funds for banks — now threatens to erode the impressive profit gains seen in recent years.

Amid these concerns, both Union finance minister Nirmala Sitharaman and RBI governor Shaktikanta Das have urged banks to intensify efforts to attract deposits. However, this raises a critical question: could these efforts come at the expense of profitability?

In an opinion piece for news website the Quint, Subhash Garg, former economic affairs secretary and former finance secretary of India, shed light on the growing challenges PSBs are facing in raising deposits and maintaining profitability.

Garg notes that while PSBs recorded a significant jump in profits to Rs 1.41 trillion in 2023-24, driven largely by higher net interest income (NIMs) and reduced provisions for non-performing assets (NPAs), their CASA deposits have been steadily eroding.

According to Garg, PSBs are currently suffering from a dual disadvantage. First, their overall deposit growth is lagging behind that of scheduled commercial banks (SCBs). Second, there has been a faster run-off in CASA deposits, which play a pivotal role in maintaining the banks‘ NIMs.

“While PSBs’ term deposits grew by 13.08 per cent in 2022-23, their CASA growth plummeted, with savings deposits growing by only 4.15 per cent, compared to much stronger figures seen in previous years,“ Garg explained.

Garg further argued that the shifting deposit mix, with more funds moving into fixed deposits (which bear higher interest rates), will lead to increased funding costs for PSBs. This, in turn, is expected to erode their profit margins.

The former finance secretary pointed out that while PSBs may be forced to raise funds through costlier fixed deposits or interest-bearing certificates of deposits (CDs), this strategy is unsustainable in the long run and will likely weigh heavily on their future profitability.

He cautions that PSBs could soon see a reversal in their fortunes as key factors contributing to profit growth — such as high NIMs and declining provisions for NPAs — have likely peaked. With repo rates expected to decline, and loan rates unlikely to rise further, the scope for profit expansion will narrow.

“Banks’ profitability, which surged on the back of rising interest rates and improving asset quality, may have reached its limit. The pressure to raise costly deposits will further erode margins, and a reversal in profitability is now on the horizon,“ Garg asserted.