India's banking sector is demonstrating strong performance, with India Ratings and Research elevating its credit growth forecast for 2026-27 to an impressive 15%, up from an earlier projection of 13%. This optimism is underpinned by a substantial improvement in asset quality, as recent data for the April-June quarter shows net non-performing assets (NPAs) for all listed banks, both public and private, dipping below 1%. This marks a significant recovery from a peak of around 6% in financial year 2018.
Deposit Growth Lags, FCNR(B) Inflows Offer Temporary Boost
Despite the robust credit expansion, deposit growth has consistently trailed, a trend observed over several quarters. However, this gap is set to narrow, albeit temporarily, thanks to strong inflows via FCNR (B) deposits. The Reserve Bank of India (RBI) initiated a special concessionary swap window to bolster foreign exchange reserves, leading to a surge of approximately $65.4 billion in FCNR (B) deposits by August 22. India Ratings has consequently revised its deposit growth forecast for 2026-27 to 13.6% from 11.4%.
Twin Near-Term Challenges: Loan-to-Deposit Ratio and Profitability
While the overall picture appears positive, Indian banks are navigating two significant near-term challenges. The first is an elevated loan-to-deposit (LDR) ratio, which has reached approximately 85% in the recent quarter, described by Karan Gupta, Head and Director, Financial Institutions, India Ratings, as the highest in many quarters.
The second challenge stems from increasing profitability pressures. Gupta highlighted that muted Net Interest Margins (NIMs) combined with an expectation of slightly elevated credit costs are likely to squeeze the sector's profitability. India Ratings projects system-wide credit costs to rise to 74 basis points (bps) in FY27, up from 65 bps in the previous year. Private banks are expected to see a higher increase, with credit costs reaching 95 bps compared to 60 bps for public sector banks.
Outlook for NBFCs and Market Normalization
Non-banking finance companies (NBFCs) face a similar outlook, with expectations of marginal profit pressure driven by NIM compression and higher credit costs. While larger NBFCs may possess adequate capital buffers, smaller entities could encounter difficulties in securing sufficient growth capital. Furthermore, volatility in capital markets has led to the postponement of several initial public offerings planned by mid-sized companies.
With banks contending with margin pressures, primarily due to compressed spreads and a greater reliance on certificates of deposit and bulk deposits, overall loan growth is anticipated to normalize in the second half of the financial year. The temporary surge in FCNR (B) deposits, however, could help lower funding costs. This, coupled with an improved asset mix, might eventually contribute to the normalization of margins, according to officials.