Deregulating deposits: What India’s experience tells us about banking today

Amid a sharp liquidity deficit, Indian banks are aggressively raising deposit rates to attract household savings – a pattern last observed over a decade ago. This article investigates what the current rush reveals about the structure of deposit markets, drawing lessons from the 2011 deregulation of savings deposit rates. Banks in competitive markets increased rates more, gathered more deposits, and extended credit to underserved sectors without sacrificing profitability.

Households across India are becoming aware that their deposits are suddenly more valuable to banks. In early 2025, some lenders offered fixed deposits at rates as high as 8%, marking the most aggressive pricing in over a decade. This is a clear indication of unusual financial stress in the banking sector. Within a few months, the system has swung from a liquidity surplus of over Rs. 1.2 lakh crore in mid-2024 to a deficit exceeding Rs. 3.3 lakh crore by early 2025, the sharpest shortfall in nearly 15 years.

Given the current situation, the Reserve Bank of India (RBI) has responded by injecting more than Rs. 11 lakh crore through¹ between December 2024 and January 2025. Yet, funding conditions remain tight. Banks have reacted to this stimulus in two ways. First, they have ramped up wholesale funding via certificates of deposit, with outstanding volumes not seen since 2012. Second, they have rolled out aggressively priced retail deposit products, from 300-day and 400-day special schemes to “super-senior” fixed deposits offering rates as high as 8% (Business Standard, January 2025). These moves reflect banks’ attempts to shore up household savings at a time when loan demand is strong, but deposits are not keeping pace. However, there is considerable divergence in behaviour, with some banks quickly raising rates and others holding back – pointing to factors beyond short-term liquidity pressures. In fact, this feature is closely tied to the structure of competition in deposit markets (Neumark and Sharpe 1992, Granja and Paixao 2021). Where banks face competition for household savings, they are compelled to raise rates and expand outreach. On the other hand, in markets with high concentration, banks can afford to do less, relying on depositor inertia or short-term wholesale borrowings (Bharat, Halder and Kulkarni 2025). Needless to say, this structural difference has implications for both financial stability and credit allocation.

A look back: Deregulation of savings deposit rates in 2011

To understand the current dynamics, we examine a key policy change from over a decade ago, that is, the deregulation of savings deposit rates in June 2011(Bharat, Halder and Kulkarni 2025). Before this change, the RBI kept these rates fixed at 3.5%, which was well below the policy repo rate ², as shown in Figure 1a below. This allowed banks to mobilise deposits cheaply but gave households little incentive to keep large balances in savings accounts. Moreover, average savings rates increased after deregulation and ranged between 3.5-4.5%, well below the repo rate with positive spreads (repo rate minus savings deposit rate) throughout 2011-2016 (Figure 1b).

Figure 1a. Savings deposit rate

Figure 1b. Savings deposit rate and spread

Source: Authors’ calculations, CEIC.

Notes: (i) Years are the financial years as of 31 March. (ii) The vertical dotted red line denotes the year of deregulation, that is, 2011. (iii) All private and public sector banks are included in the analysis.

The deregulation permitted banks to set their own savings deposit rates, fostering competition in the most common deposit product. Our research exploits this episode to answer an important question: when given the ability to set prices freely, which banks competed for household deposits, and what were the wider implications for financial intermediation? This surge in competition for savings, we show, was not just a temporary response to a liquidity crunch, but a lasting lesson from policy reform: when banks are allowed to compete more freely, households gain better returns, and the economy benefits from more efficient intermediation.

Market power and competition: Evidence from branch-level data

Our main argument is that setting low deposit rates enables banks to raise cheap deposits and makes investing in government securities profitable, akin to a form of financial repression (Chari et al. 2020), while simultaneously restricting credit access for households and firms. The study uses the deregulation episode as a natural experiment to show that when deposit rates are liberalised, banks with less market power raise their rates more significantly, resulting in higher deposit inflows, a move away from low-yielding government securities, and towards more credit to productive sectors, including households and small businesses with limited financial resources.

We make use of detailed branch-level data from the RBI covering all Indian districts for the period 2007-2016. To measure differences in competitive exposure, we construct a bank-level indicator of market power: a deposit-weighted Herfindahl-Hirschman Index (HHI) based on the distribution of branches across districts. Banks with below-median HHIs are classified as "low-market-power" (operating in more competitive environments), while those above the median are "high-market-power" (operating in more concentrated local markets). This measure shows how concentrated a bank’s depositor base is and, therefore, how much pricing power it has over depositors.

How banks responded to deregulation

We find striking differences in how banks responded after deregulation. Those operating in more competitive markets (with lower market power) moved quickly to raise savings deposit rates. As a result, their deposit base expanded much faster. Savings deposits grew by 16% more compared to banks with greater market power, while overall deposits rose by 13.5% (Figure 2). Based on our calculations using RBI data for 2007-2016, we see that as a spillover effect, term deposits and current accounts also experienced growth. As higher returns drew in households, they consolidated more of their financial activity with these banks.

Figure 2a. Savings deposit rates: Low HHI versus high HHI banks

Figure 2b. Savings deposit spread: Low HHI versus high HHI banks

Source: Authors’ own calculations; CEIC, RBI.

The effects on the lending side were equally important. Low market-power banks increased total lending, raising their credit-to-deposit ratios. Loan maturities shortened as banks relied more on liquid funding, and credit also flowed into sectors such as industry, services, MSMEs (micro, small, and medium enterprises), and personal loans that had long been underserved. At the same time, these banks reduced their holdings of government securities and redirected funds towards private lending.

Under the earlier regime, banks had little incentive to compete as low savings deposit rates had let them earn comfortable margins while parking money in government paper. Deregulation unsettled that balance and pushed more competitive banks to adopt productive lending strategies.

A natural concern that arises under the new regime is the potential for bank profitability to be squeezed due to higher deposit rates. However, our evidence suggests otherwise. Despite paying more for deposits, low market-power banks remained profitable by expanding loan volumes. Importantly, households benefit from increased competition. Districts with greater exposure to these banks experienced stronger deposit growth and improved access to credit.

These finds have a bearing on banking today. Current liquidity pressures have prompted banks to raise deposit rates and expand retail outreach. However, the adjustments are uneven: smaller banks are launching promotional products to attract savers, while larger banks depend on depositor loyalty or wholesale funding. This creates two main risks. First, when banks rely heavily on wholesale instruments like certificates of deposit, they face rollover risk, that is, if market sentiment shifts, refinancing can suddenly become costly or unavailable. This may be especially problematic if deposit market competitiveness stems from institutional features, such as the implicit guarantee of deposits of public sector banks. Second, in markets dominated by a few banks for household deposits, the connection between RBI policy and deposit rates weakens. Without the pressure to compete, these banks are slower to pass on repo rate cuts similar to the deposit channel of monetary policy postulated by Drechsler et al. (2017)³.

Finally, liquidity cycles are inherently shaped by tax flows, capital movements, and central bank operations. But their ultimate consequences are mediated by the structure of financial markets. The deregulation of 2011 offers a clear lesson: in competitive markets, banks mobilise household savings more effectively, channel funds into underserved sectors, and deepen financial intermediation. Where markets are concentrated, deposits stagnate, safe assets dominate, and credit to firms and households is held back.

Policy lessons

Our analysis indicates that reverting to administered deposit rates would be a step backward, reintroducing distortions that reforms aimed to eliminate. Policymakers should instead focus on maintaining open and competitive deposit markets. This could involve publishing district-level concentration data, ensuring clearer disclosure of deposit rates, making accounts more portable, and encouraging banks to expand both physically and digitally in concentrated markets.

In today’s context of tight liquidity, while deregulation can improve financial intermediation, high bank market power can limit these gains, effectively creating a form of financial repression by suppressing deposit rates and channeling funds into government securities rather than productive credit. Thus, stronger competition in deposit markets is not only about offering savers better returns, but it is a lever for resilience, monetary transmission, and inclusive growth.

Notes:

Variable Rate Repo (VRR) operations are an RBI tool where banks bid for short-term funds at market-determined interest rates via auctions to manage liquidity in the banking system.
The repo rate, or repurchase rate, is the rate at which central banks lend to commercial banks, usually against government securities. It is an essential monetary policy tool, affecting the money supply and overall economic activity.
In Drechsler, Savov and Schnabl (2017), the “deposits channel” works through banks’ market power in deposit markets. When monetary policy tightens, banks raise the spread between the policy rate and deposit rates, causing deposit outflows. That shrinks their funding base and forces them to cut loan supply – even holding lending opportunities constant.