The volume of savings in an economy is a fundamental determinant of capital formation....

 The most significant variables for capital formation can be broadly categorized into three stages: the creation of savings, the mobilization of savings, and the investment of those savings. The volume of savings in an economy is a fundamental determinant of capital formation. A higher per capita and national income directly increases the ability of individuals and entities to save more. Beyond income, people must have the desire to defer present consumption for future security or investment opportunities. This is influenced by personal considerations, family needs, and a desire for progress. Favorable tax policies, such as tax benefits on saved income, encourage individuals and corporations to save and invest. High taxes on income and profit can have an adverse effect on savings. Attractive interest rates on savings can motivate people to save more. For businesses, retained earnings (profits not distributed as dividends) are a key source of self-financing for new capital projects. There is a strong need for bank deposits to compete with other investment assets. This competition is crucial for both the financial stability of banks and the broader economy, as investors actively shift their funds to alternatives offering higher perceived returns or better features like tax incentives.

Mobilization of Savings

Savings must be collected and transferred to those who can invest them in productive assets. A well-developed network of banks, insurance companies, mutual funds, and capital markets is crucial for channeling savings from individual savers to entrepreneurs and investors. Easy access to loans and credit facilities, particularly for potential investors, facilitates the acquisition of funds needed for investment.

Investment of Savings

The actual use of mobilized savings for creating new capital goods is the final stage. The presence of daring entrepreneurs who are willing to take risks and identify profitable investment opportunities is vital. The availability of essential infrastructure (power, transportation, communication, etc.) and allied general facilities encourages private and public investment by lowering costs and expanding market potential.

Overall economic climate

A favorable overall economic climate, stable market conditions, and good potential for profit are strong motivators for investment. Innovation and the availability of advanced technology can stimulate capital formation by enabling more efficient production methods and encouraging investment in new equipment and R&D. A stable political environment and the security of life and property are fundamental for long-term investments. Investment in education, health, and on-the-job training creates skilled labor, which is essential for developing and utilizing physical capital effectively.

Gross domestic savings

India's gross domestic savings rate for the financial year 2023 was reported as 30.2%, a slight decrease from 31.2% in FY2022.This figure is considered high compared to the global average of 28.2%.

Household savings and debt

Household net financial savings dropped to a 43-year low of 5.3% of GDP in FY2023. This decline coincided with a surge in household financial liabilities, as households borrowed more for consumption and housing. The share of bank deposits within financial savings has been decreasing, while investments in mutual funds and equities have been rising, particularly in urban areas. There has been an increase in physical savings, such as real estate, relative to financial savings.

Funding for Banks

Deposits are a primary, stable, and low-cost source of funds for banks, which they use to finance loans and maintain liquidity. When deposits are not competitive, banks must turn to more expensive or less stable sources of funding, such as wholesale money markets or certificates of deposit (CDs), which increases their cost of capital, reduces profit margins, and poses liquidity risks.

Investor Behavior

Savers are rational and seek the best possible return on their money given their risk appetite. If investment options like mutual funds, equities, and other market-linked instruments offer significantly higher returns (especially in times of high inflation), investors will increasingly move their savings away from traditional bank deposits. This trend is already evident in some markets where mutual fund assets under management (AUM) are growing faster than bank deposits.

Systemic Risk

A significant gap between credit growth (bank lending) and deposit growth can create systemic risks in the banking system, an issue highlighted by regulatory bodies like the Reserve Bank of India (RBI). Banks need a robust deposit base to support lending and overall economic growth.

Monetary Policy and Innovation

Competition forces banks to be more efficient and innovative. They may offer more attractive interest rates, introduce new features like sweep-in facilities, or improve their digital services to attract and retain depositors. This competitive environment also aids in the effective transmission of monetary policy, as interest rate changes have a more direct impact on household saving decisions.

Risk vs. Return Trade-off

Bank deposits are traditionally considered very safe, often backed by deposit insurance, which guarantees returns and protects the principal from market volatility. Other assets carry higher risk but offer the potential for greater returns. For deposits to remain an attractive option for a portion of an investor's portfolio (especially for risk-averse individuals or for emergency funds), they must offer a return that is reasonably competitive, particularly against inflation.  

In essence, capital formation is a process driven by a healthy interplay between savings potential, an efficient financial system, and a conducive environment for productive investment in both physical and human capital. India's personal savings rate is debated, with some sources citing a high gross domestic savings rate of 30.2% for FY2023, while other reports indicate a significant decline in household net savings, which fell to a 43-year low of 5.3% of GDP in FY2023. This discrepancy is attributed to a surge in household debt to finance consumption and housing, a shift from traditional bank deposits, and a rise in physical savings like real estate over financial savings. Bank deposits must be competitive with other investment assets to ensure a stable funding base for the banking sector and to prevent a mass exodus of household savings to other financial intermediaries. Without sufficient competition (primarily through attractive interest rates and product features), banks face higher funding costs and liquidity challenges, while investors may miss out on suitable low-risk saving options that keep pace with inflation. Therefore, maintaining the competitiveness of bank deposits is a critical aspect of a well-functioning and stable financial system.