Seminar by Yogeshwar Bharat (CAFRAL)

Regulated banking systems with mandated fixed saving deposit rates below the prevailing market rates allow banks to raise deposits cheaply. Consequently, banks lean towards safer assets like government securities, limiting resources available for loans. We examine a 2011 deregulation episode in India using data from Indian banks from 2006 to 2016. Banks with higher deposit beta saw an increase in deposits by 13.6% compared to lower deposit beta banks. Similarly, high deposit beta banks’ loan were 26% higher than lower deposit beta banks. We construct a static banking model with heterogeneous banks and depositors to explain these empirical findings. Our paper underscores how deposit rate regulation can shape bank asset portfolios, potentially intensifying credit constraints and limiting the level of financial intermediation in the economy. By highlighting the impact of deposit rate deregulation in stimulating bank investment in high-yielding projects, our study aims to showcase how deregulation can alleviate credit shortages and promote economic growth.