The landscape of household financial savings in India is undergoing a noticeable shift. While, traditionally, our fathers’ and grandfathers’ savings were dominated by bank deposits (BD), there is now a significant reallocation toward mutual funds (MFs). This emerging trend sparks a question on whether mutual funds are growing at the expense of bank deposits.

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Says Dipanwita Mazumdar, Economist at Bank of Baroda (BoB), “There have been debates that increase in AUM (assets under management) of MFs (mutual funds) are happening at the cost of bank deposits, with conjectures that lucrative returns, the promise of higher earnings of companies and a stable growth environment have turned the compass from a traditional savings set-up to a market-oriented investment tendency,”

Though this shift appears evident, a statistical analysis by Mazumdar presents a more nuanced picture, raising questions about the permanence and extent of this transition.

The take-off phase of rechanneling instruments from deposits to MFs was glaringly visible in FY22, the data reveals. The share of deposits in gross financial savings of households, albeit considerably higher at 29.4 per cent has witnessed a deceleration from 33 per cent (in the long-run average). The share of MF on the other hand has risen considerably to 6 per cent from 2 per cent (long run average). “The quantum of the two may not be comparable, but it cannot be denied that some re-jigging is happening,” Mazumdar notes.

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Growth Trajectory: Mutual Funds v/s Bank Deposits

The BOB data reveals that the growth in mutual funds has far outpaced that of bank deposits in recent years. The compound annual growth rate (CAGR) of MF is double that of BD at 20.5 per cent for the past 10 years, whereas for BD, it is at 10.3 per cent.

The sharp increase in ratio was seen particularly during post-Covid period which coincided with a buildup in precautionary savings of households, the report states. The trend where mutual funds have consistently outgrown bank deposits has become strikingly noticeable, particularly since November 2023, the data shows. The ratio of AUM of mutual funds to GDP has climbed to 18.1 per cent, the highest ever recorded, while the bank deposits-to-GDP ratio has dipped to 69 per cent in FY24 from 76.1 per cent in FY21.

A Structural Shift or A Transient Phase?

The critical question remains: is this shift from BD to MFs structural and likely to persist or transient phase fueled by temporary market conditions? On the surface, the data shows rebalancing of portfolios, with households increasingly favouring mutual funds over bank deposits. The elasticity of BD to MF has declined 0.35 in the post-Covid period, which reflects households’ changing behavioral patterns. Therefore, some bit of crowding out of BD by MF is noticeable according to the data. However, the growth in both bank deposits and mutual funds, albeit at different rates, complicates the narrative.

Statistical Analysis: A Lack of Causality

The BoB analysis determines whether there is a causal relationship between the growth of mutual funds and the decline in bank deposits. By applying a Granger causality test to data from October 1999 to July 2024, the report finds that mutual funds do not cause a decline in bank deposits, and vice versa.

Moreover, as per ‘the cointegration tests’ no long-term relationship between the two variables (MFs and BDs), suggests that the apparent substitution effect could be more complex than a direct cause-and-effect scenario.

The report could not identify if there is a causal relationship statistically between growth in deposits and mutual funds. When the analysis was broken down into two periods, pre-Covid (FY14-19) and post-Covid (FY20 onwards), the results remained consistent.

Why the Data Falls Short?

The report identifies various reasons why the statistical data does not conclusively capture a substitution effect between MFs and BDs. Firstly, the report states that the recent surge in mutual fund investments is a relatively new phenomenon, with much of it originating from a low base. Hence this can be a reason for the absence of significant relations between the two. In terms of plain elasticities, there has been a lower number in the period starting FY20 when mutual funds gained in ascendency.

In addition, both mutual funds and bank deposits have continued to grow, albeit at different rates, making it challenging to establish a clear negative correlation. The findings indicate that the simple correlation coefficients between the two variables have never turned negative which further complicates the analysis.

The analysis has been drawn by noting long-term relationships while ignoring short-term dynamics, contributing to the inconclusive results.

A more insightful approach would involve analysing the ratio of mutual funds and bank deposits to the total financial assets of households, Mazumdar states. This would provide a clearer picture of how the share of each instrument is evolving within the broader savings portfolio. However, the lack of a long-term data series for this metric remains a limitation.

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Will this Shift Sustain?

The surge in growing MF investments is closely interlinked with the booming stock market. However, this in turn raises questions about the sustainability of this trend. For instance, if market conditions continue to be favorable, MFs will continue to attract a larger share of household savings. On the other hand, if the market faces a downturn, given its volatility, households may revert to the safety of bank deposits.

For the period of FY14 to FY19 stock index changes explained just 11 per cent of the variation in AUM (the coefficient of determination). For the period FY20 onwards to July 2024, this ratio went up to 56 per cent while the coefficient for the stock index remained range bound, the data shows.

The steady relationship between stock market indices and mutual fund AUM suggests that the growth of mutual funds is heavily dependent on market performance.

While there is a visible shift in household savings from bank deposits to mutual funds, the statistical data does not support a direct causal relationship between the two. The growth in mutual funds appears could be part of a broader financial trend in savings behaviour driven by higher returns and a favourable (yet highly volatile) market environment.