By R. Suryamurthy
There is an odd sense of comfort in India’s savings revolution — as if we are watching a financial transformation gather speed while pretending there is no downside to it. Mutual funds have become the new cultural shorthand for “smart money”, the aspirational badge of financial maturity, the digital-age equivalent of old fixed deposits. Every commercial tells households that systematic investment plans (SIPs) are the highway to wealth; every influencer urges people to “stay invested” as though that alone guarantees prosperity. It is a seductive story, but one that obscures the far more complicated and risky truth underneath.
The sheer scale of the shift should make policymakers sit up. Mutual fund assets under management (AUM) have jumped from ₹22 lakh crore in FY20 to nearly ₹80 lakh crore by October 2025 — a 260% explosion. Bank deposits, by contrast, grew from ₹136 lakh crore to ₹242 lakh crore over the same period. Even though deposits remain the bigger pool, it is the velocity of change that matters. Deposits’ share in the combined deposits-plus-mutual-fund savings pool has dropped from 85.9% to 75.2% in five years. More telling, the share of deposits in incremental savings — the new money households put aside each year — has crashed from 89.5% in FY23 to just 52.5% in October 2025. In other words, half of every fresh rupee Indians save is no longer going into banks. It is going into market-linked products, often without the understanding that markets do not go up in straight lines.
What has turbocharged this shift is quite obvious: a once-in-a-generation bull market that has masked almost every structural weakness underneath. The NIFTY index has nearly tripled since March 2020. Small-cap stocks are up 120% in three years. Mid-caps have doubled. Valuations are sitting at historic highs, with small-cap price-earnings (P/E) ratios soaring above 60 — levels that even seasoned managers privately describe as uncomfortable. A great deal of India’s newfound investment culture is built on an abnormal streak of uninterrupted good news. A large portion of the 3–4 crore new retail investors have never experienced a multi-year downturn, only a series of V-shaped rebounds that reinforce the illusion that markets always recover quickly. It is a dangerous form of muscle memory.
And while households rush into mutual funds, the banking system is quietly bearing the cost. Slow deposit growth is not a mild imbalance; it is a structural threat to India’s credit engine. Banks depend on cheap, stable retail deposits for lending to micro, small and medium enterprises (MSMEs), homebuyers, industries, and infrastructure. But credit demand has consistently outpaced deposit growth for four straight years — 15–16% versus 11–12%. The credit-deposit (CD) ratio touched 82% in 2025, one of the highest in decades.
The Reserve Bank of India (RBI) has had to inject ₹2.5 lakh crore through variable rate reverse repo (VRRR) auctions simply to keep liquidity from choking. When half of new household savings no longer flow into banks, the consequences are predictable: banks raise deposit rates, margins shrink, lending tightens, and dependence on expensive wholesale funding rises. Public sector banks (PSBs), which lack the agility of private peers in mobilising depositors, feel the squeeze even more sharply. This widening mismatch between savings behaviour and banking liquidity is the kind of slow-moving imbalance that tends to erupt only when the cycle turns.
But the far more immediate vulnerability is with households themselves. More than 82% of individual mutual fund assets are now concentrated in equity and hybrid schemes. Small- and mid-cap categories are bloated and overcrowded, with too few fundamentally strong stocks being chased by too much retail money. Thematic funds — among the most volatile products in the mutual fund universe — now account for 6.7% of AUM. These are not signs of deep, steady long-term investing. They are signals of performance-chasing behaviour, intensified by digital apps that turn investing into a near-frictionless impulse action. The problem is not that retail investors want higher returns; the problem is that they do not recognise the risk they are carrying. Many treat mutual funds as the new fixed deposits — steady, liquid, benign — without grasping that a 25–30% fall in net asset value (NAV) is not unusual but a normal part of the market cycle.
The illusion of liquidity is perhaps the most quietly dangerous part of this story. Investors believe they can redeem whenever they wish, as easily as breaking a fixed deposit. But history suggests otherwise. In 2020 and again in 2022, several funds had to impose temporary restrictions, apply steep exit loads, or liquidate assets at sharply lower prices. Internal stress tests conducted in 2025 show that small-cap funds can meet only about ₹40,000 crore of daily redemptions without inflicting an 8–12% NAV hit. Liquidity is abundant in a rising market; it evaporates the moment investors head for the exit at the same time.
This brings us to the increasingly fragile relationship between mutual fund flows and market valuations. Domestic mutual funds bought ₹3.5 lakh crore worth of equities in 2024–25 even as foreign investors collectively sold ₹1 lakh crore. The market is now being driven more by domestic flows than global ones — a reversal that is often touted as India’s arrival as a mature financial market. But it also creates a feedback loop: inflows push prices up, rising prices attract more SIPs, and more SIPs push prices further up. When such loops break, they do so with far more force than most people expect. Economists like Ruchir Sharma and Sanjeev Sanyal have already warned that the small- and mid-cap segments exhibit classic bubble characteristics. The worry is not that a correction will come — because it will — but what happens when it hits a retail-heavy, valuation-rich, liquidity-thin corner of the market.
There is also an underappreciated link between the mutual fund mania and India’s derivatives explosion. Retail futures and options (F&O) trading now clocks ₹1,200 lakh crore per day. Studies by the Securities and Exchange Board of India (SEBI) show 90% of retail traders lose money, and when those losses accumulate, investors often redeem their mutual fund units to cover margin calls. This creates a bizarre, indirect contagion channel: volatility in derivatives markets spilling into cash markets via forced mutual fund redemptions. It is hard to call this a healthy ecosystem.
The macroeconomic implications of a correction are even more sobering. If households lose wealth in a downturn, they cut consumption. When consumption falls, GDP growth slows. India has never previously had a household savings structure so tightly tied to equity-market performance. Deposits, by design, shielded households from volatility. By shifting aggressively toward market-linked assets, India is increasing the sensitivity of its growth cycle to financial market shocks. A 25–30% correction — absolutely normal in global market history — could simultaneously erode household wealth, drain bank liquidity, and dent market stability. Policymakers understand the risk; recent warnings by the RBI Governor, SEBI officials and the Chief Economic Advisor underline the discomfort. But systems often react only after damage is visible.
None of this is to argue against financialisation or mutual funds. India needs deeper markets, more equity participation, and better long-term wealth creation. The shift away from deposits is in many ways inevitable. But speed without safety is a precarious foundation. Household behaviour has changed faster than regulatory frameworks, faster than investor education, faster than the development of bond markets or pension products that could act as stabilisers. The savings revolution is real — but the risk revolution is running far behind.
India’s mutual fund fever may continue as long as the market keeps rising. And perhaps it will rise for a while longer; cycles can defy logic for absurdly long periods. But markets eventually correct. When they do, the true extent of the vulnerabilities built into India’s new savings architecture will finally come into view. The real question is whether India will recognise the warning signs now — or only after the correction forces households, banks and policymakers into the kind of uncomfortable reckoning that hindsight always makes look obvious. (IPA Service)
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