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In any macroeconomic framework, the household sector plays a critical role as a driver of consumption, savings, and overall economic activity. Household consumption is primarily influenced by income and wealth. In India, the household sector has traditionally favored fixed deposits (FDs) in banks and other small savings instruments such as postal schemes and Public Provident Fund (PPF), which offer fixed returns. Known for their low risk, guaranteed returns, and flexible tenure, FDs—particularly those from scheduled commercial banks—have been popular among the elderly, who prefer the security of passive income. Additionally, five-year bank deposits remain a favored investment for tax-paying individuals who can claim tax deductions under Section 80(C) of the Income Tax Act.

A deeper analysis shows that India’s middle class grew from 14% in 2004-2005 to 31% in 2021-2022. However, limited disposable income after meeting financial obligations has led middle-class investors to prioritize low-risk investment options. With rising incomes and greater financial responsibilities—such as better education, healthcare, and ensuring a stress-free future—many are risk-averse and shy away from market-linked investments. However, preferences for FDs have evolved. Inflation has eroded the real rate of return on FDs, making them less attractive. An article titled “Estimating the

Financial Wealth of Indian Households,” published in the RBI’s July 2023 bulletin, highlighted that while deposits have maintained their dominance in household financial wealth over the last decade, there has been increasing interest in other investment options, such as equities, mutual funds, and insurance. The share of equities in total financial wealth has surged by over 50% between 2011-12 and 2022-23. Bank deposits, which once made up more than half of the financial wealth portfolio before 2011, have fallen to 43% as of March 2023.

Banks rely heavily on household savings mobilized through current accounts, savings accounts (CASA), and time deposits as their primary lending resources. Around 80% of household credit demand is met by banks, which are mandated to meet stringent lending targets to drive economic growth. Therefore, the shift of household savings from bank deposits to other in-vestment avenues is concerning. The rising gap between credit and deposit growth has been flagged by the Reserve Bank of India (RBI) Governor, who warned that this could “potentially expose the system to structural liquidity issues.” He noted, “There will always be some gap between the two, but credit growth should not outpace deposit growth by such a wide margin.”

Both policymakers and adminis-trators are understandably alarmed. Such an imbalance in the banking ecosystem could disrupt the flow of funds. With credit demand surging and deposit growth lagging, the credit-deposit ratio (CDR) hit 80% in March 2024, the highest since 2005. In 2023, credit growth reached nearly 16%, while deposits grew by only 13%. In previous years, the gap was even wider (e.g., 15% vs. 10% in 2022), with the exception of the pandemic years, when credit demand was muted, and deposits surged.

This trend can be partly attributed to the relatively low interest rates on bank deposits, which have led frustrated households to shift their investments toward capital market instruments. The stock market’s bull run, combined with the convenience of trading apps and transparent settlement systems, has encouraged this shift. Even those wary of direct equity investments have turned to mutual funds, which have seen unprecedented growth in recent years. In contrast, bank FD interest rates now pale in comparison to market returns, despite the volatility of market-linked investments. Another deterrent has been the tax treatment of FDs compared to debt funds. Until the 2023 Budget, debt funds enjoyed indexation benefits and lower long-term capital gains taxes, while FD interest was taxed at the depositor’s income tax slab rate. Although this anomaly was corrected in the

2023 Budget to create a level playing field, banks have made little effort to reposition FDs as attractive investment options. Other than tweaking interest rates and tenures based on monetary policy guidelines, banks have not rebranded FDs, relying on their perception as stable, fixed-rate products—a perception that is now outdated.

At one level, the decline in deposits reflects savvier savers shifting toward higher yields and greater risk tolerance. However, on another level, the base of younger

savers—millennials—has not expanded rapidly enough to replenish the banking system. This generation’s more spendthrift lifestyle and investment preferences have left the banking channel under pressure. Simultaneously, banks’ role as financial intermediaries may be diminishing, as capital markets offer companies direct access to funding via bonds and equity at lower costs than traditional bank loans.

This dual pressure on both the supply and demand sides of the banking system raises serious concerns. Without innovation, the banking system could face significant challenges. The question arises: how can an economy thrive if its banking system falters? To address the “structural liquidity issue” high-lighted by the RBI Governor, innovative solutions are needed.

One possible solution is to remove taxes on interest earned from bank deposits, subject to an annual cap. Another idea is to offer differential interest rates for online FDs, similar to what some non-banking financial companies (NBFCs) have done. A more radical proposal would be to centralize public deposits with the RBI, allowing banks to act as intermediaries for assessing loan risk and pricing. The RBI could hold depositor funds in e-rupee accounts, paying periodic interest, while banks access these funds at a special rate for longer-term lending.

In today’s technology-driven environment, there are many tools available to help banks innovate and develop new products. With the banking ecosystem in flux, now may be the ideal time to experiment with such novel strategies.