KUALA LUMPUR (REUTERS) - Bank deposits in Malaysia are growing at their slowest pace in more than a decade as retail funds flee to higher-yielding avenues, weakening banks' buffers against any unforeseen funding needs at a time when the economy is losing steam.

Total deposits at commercial banks rose 4.8 per cent in July, the least since September 2002, according to the latest central bank data. Growth is expected to slacken further, with banks offering unattractive interest rates of 3.1 to 4.0 per cent per annum. Those rates are barely above the inflation rate of around 3 per cent.

Most Malaysians still prefer property, equities and other investments than deposits, say analysts.

As deposits slow, banks' loans-to-deposits ratio - a measure of their liquidity - crept to a record 89.3 per cent at the end of July. Some of the bigger lenders such as Malayan Banking Bhd are currently operating at loan-to-deposit ratios above 85-90 per cent, according to analysts. They expect the sector-wide ratio to rise further and liquidity to tighten, even as loan growth in the Southeast Asian country slows due to a weaker economy.

Banks have not been idle. They have been raising interest rates after the central bank increased its overnight policy rate by 25 basis points to 3.25 per cent in July last year. Competition has also kicked up a notch ahead of a 2019 deadline to comply with Basel III capital requirements.

As banks raise interest rates to attract deposits, net interest margins - or the difference between what banks pay on deposits and receive for loans - will suffer, analysts warn.

"We do not discount the possibility of these banks paying up (raising rates) for deposits, and this would be negative even for banks with more liquid balance sheets, as these banks would likely need to pay up for deposits as well, in order to defend their market share," an analyst with RHB, a Kuala Lumpur-based bank, told Reuters.