Tenacity thrives; talent taps out!
Do you ever hesitate to check your bank balance?
Many of us rely on digital payment platforms, and sometimes we know we’ve overspent but still avoid checking our bank balance.
Instead, we convince ourselves with thoughts like, “Next time, I’ll be more careful.” But often, that “next time” never comes.
This behaviour isn’t just procrastination; it’s known as the Ostrich Effect.
What is the Ostrich Effect?
The ostrich effect is a mindset where people avoid or ignore uncomfortable news or problems, hoping they will disappear on their own.
The name comes from the myth that ostriches bury their heads in the sand to avoid danger.
We often fall into this behaviour when we’ve already made a decision and don’t want to face its drawbacks or risks. In fact, a study has found that investors tend to check their portfolios more often when markets are doing well. But when markets dip, they avoid looking at their investments altogether.
This habit of "ignoring the problem" won’t help; in fact, it often makes things worse.
Instead, try not to let the market’s ups and downs control your actions. Check your investments regularly, pay attention to changes, and look at the big picture.
This way, you can make better decisions and keep your financial plans on track.
MEME OF THE WEEK:
Market Kya Keh Raha Hai, Sir?
Indian banks are facing liquidity crises and the root cause lies in the growing credit-deposit gap, a concern that was initially highlighted by former RBI Governor Mr. Shaktikanta Das during the BFSI Summit in July 2024.
A key factor in this crisis is the decline in CASA (Current Account Savings Account) deposits. But why is CASA so important, and what does its decline mean for banks? Let’s break it down.
What is CASA and Why Does it Matter?
CASA stands for Current Account and Savings Account deposits, which represent the funds customers keep in these accounts. These deposits are a cheap source of funds for banks because they offer little to no interest in comparison to other deposit types. This low cost makes CASA deposits essential for banks to maintain profitability.
Here’s how it works:
Banks use CASA funds to issue loans: The profit they earn comes from the difference between the interest paid on deposits (low in the case of CASA) and the interest charged on loans.
Higher CASA Ratio = Lower Cost of Funds: When banks have more CASA deposits, their funding becomes cheaper, which is good for both profitability and liquidity.
However, the CASA ratio in Indian banks has been declining, forcing banks to rely on more expensive sources of funds, such as term deposits or market borrowings. This shift is adding significant pressure to their liquidity.
The Rising Demand for Credit
Compounding the problem is the rising demand for credit. This growth is largely fueled by:
Government Infrastructure Push: Massive investments in infrastructure have increased the need for loans, particularly in sectors like real estate, energy, and transportation.
Corporate Credit Growth: Companies, especially those in infrastructure and industrial sectors, are borrowing more to meet expansion needs.
To bridge the gap between declining CASA deposits and surging credit demand, companies are turning to the corporate bond market.
By the end of December 2024, Indian firms had raised a record ₹10.67 trillion ($124.81 billion) through bonds, a 9% increase over 2023.
Why Are Bank Deposits Slowing Down?
Some say that people are putting their money into stocks and mutual funds instead of bank accounts, leading to slower growth in bank deposits.
At first glance, it seems logical: if I invest more in stocks and mutual funds, I have less to put in bank deposits. However, if one person is buying, the other person has to sell to complete the transaction.
Rather, we can say this: the public’s preference is shifting from bank deposits to other financial securities. A few reasons for this are:
Unchanged Repo rate: RBI has kept its repo rate (the rate at which it lends to banks) unchanged. Due to this banks also maintained steady interest rates on longer duration deposits, in given dynamic of low saving account rates, people might prefer investing in options that offer better returns.
Rising Inflation: High inflation reduces the real value of the interest earned on bank deposits. In simple terms, even if you earn interest, rising prices can make your money’s buying power weaker. This can push people to explore other investments that give returns high enough to beat inflation, rather than sticking to savings accounts.
Government policies: In 2022, the government started using a "just-in-time" cash management system. This means they release funds to banks only when it’s needed, instead of keeping large amounts of money in bank accounts. As a result, banks have less extra cash to work with, which makes it harder for them to lend freely or maintain high liquidity.
Consumer Credit
Over the past two years, credit growth increased rapidly compared to deposit growth, especially in credit cards and personal loans.
To deal with this situation, RBI is actively taking some major steps to narrow the Credit-Deposit gap.
What’s Next for Indian Banks?
Although loan and deposit growth rates are beginning to align, the liquidity shortage remains a significant concern that requires attention.
To address this shortage of cash in the banking system, the RBI has taken few measures:
Reduced the Cash Reserve Ratio (CRR)
CRR is the percentage of a bank’s total deposits that it must keep with the RBI as a safety measure. This money cannot be used for lending or investments, ensuring that banks always have some reserve.
The RBI reduced the CRR by 0.50% (50 basis points) in two steps of 0.25% each, bringing it down to 4% of the banks’ total deposits.
By doing this, the RBI added about ₹1.16 lakh crore (₹1.16 trillion) to the banking system, giving banks more cash for their operations.
Well, this measure helped a lot but wasn’t enough to completely sort the liquidity shortage.
Variable Rate Repo auction
On December 27, 2024, the RBI conducted a 14-day Variable Rate Repo (VRR) auction to provide banks with additional cash.
In a repo auction, banks borrow money from the RBI for a short time and repay it with interest. During this auction, banks borrowed ₹1.28 lakh crore, paying an average interest rate of 6.53%, which is slightly higher than the RBI’s standard repo rate of 6.50%.
This shows that banks are still facing cash shortages and are willing to pay more to borrow money.
Despite these challenges, banks remain in an overall strong position with high Return on Equity (ROE) and low Non-Performing Assets (NPAs). (loans where borrowers have defaulted).
However, banks must continue to focus on managing their growth prudently. It will be interesting to observe how they balance growth, maintain asset quality, and address the liquidity crunch.
What More Caught My Eye:
Isolationism won’t make anyone great again by Raghuram Rajan
Why is Ketan Parekh Back in the News?
The mindblowing story behind Caratlane
How to analyse balance sheet?
India's New Industrial Cities Hold Hope for Growth
Recommendations:
This week, I recommend watching this session of Mr. Rajeev Thakkar from the 8th Value Investing Pioneers Summit.
In this talk, he explains investment strategies & principles and warns against blindly following market trends or investing in overpriced assets.
He also focuses on key ideas like starting valuations and understanding the difference between overall sector growth and value-accretive growth.
A must-watch session as it gives you the best insights on value investing!
Thank you for reading this week's newsletter!
Hopefully, you've enjoyed reading it as much as I enjoyed writing it.
Do like, comment, share, and restack—your support encourages me to provide valuable insights.
Song of the Week:
This is Parth Verma,
Signing off.
Great share
Well written 👍❤️