Banks are not able to resort to a sharp cut in their lending rates because their share of current and savings account (CASA) deposits has come down by a significant amount for the half fiscal year ending on September 30th. These deposits are important for banks as they are considered to the cheapest source of liquid money.

With a fall in CASA, banks face a shortage in their cash supply and therefore it becomes difficult for them to reduce the lending rates. According to the finance ministry, CASA deposits for most banks have come down by 2% to 4% during this period.

These CASA deposit are the cheapest source of funds for the banks because they pay around of 3.5% interest on savings accounts and zero interest on current accounts. Banks consistently try to increase this share because a fall in this front hit their margin in the long run. "Lower ratio of CASA reflects in higher cost of funds for a bank. It may also affect the yield (profitability) of the bank (from its advances or loans)," said V K Dhingra, Executive Director of UCO Bank.

Most public sector banks witnessed a fall in their CASA deposits between March and September 2008. It fell by 3% for the largest lender, State Bank of India (SBI) and even for Bank of Baroda, Bank of India, Canara Bank, and Oriental Bank of Commerce, these CASA deposit came down by a sizeable amount.

The main reason for a fall in CASA deposits was the rising interest rate of fixed deposits. Banks have been offering high interest rates on fixed deposit to attract more funds. Interest rates increased to 10.5% for deposits that were parked for more than a year. Besides the rates for bulk deposits [link] were even higher and this attracted customers who shifted their funds from savings and current accounts to fixed deposits that earned high returns.

"There has been a fall in the ratio of CASA deposits because of high interest rate on fixed deposits. The facility of flexi-deposits also attract customers towards term and fixed deposits" said an official with Oriental Bank of Commerce.

Flexi-deposits are fixed deposits whereby the investor can earn fixed interest rate along with a facility to partially withdraw money before the tenure of the deposit is complete. On the other hand, an investor has to pay a penalty if he chooses to withdraw money from his fixed deposit before the maturity period.

Earlier also it was noticed that the CASA deposits of public sector banks have declined and now these banks are adopting new methods to increase their CASA deposits. A rise in bank's CASA deposits means that its cost of funds is reducing that will allow it lend at a cheaper rate.