Whalesbook
Strong Loan Demand Fuels Growth
Indian financial institutions anticipate a strong year ahead, with corporate loan books expected to expand by double digits. State Bank of India (SBI) projects 13% to 15% growth in its corporate segment, supported by a ₹5.5 lakh crore pipeline, driven by demand from sectors like infrastructure, renewable energy, and manufacturing. Bank of Baroda (BoB) aims for 10% growth, backed by a ₹50,000 crore pipeline, seeing particular strength in renewable energy, data centres, and commercial real estate. Axis Bank has already shown significant momentum, with its corporate loan portfolio growing 38% year-on-year. This surge in lending shows healthy demand from businesses for investment and working capital.
This rapid loan growth comes as the financial system faces increasing strain. Banks, especially public sector undertakings (PSUs), are navigating a funding environment where loans are growing faster than deposits. Macquarie Capital Securities warned that current liquidity coverage ratios (LCR) leave little room for more loan growth without more deposits. They suggest public sector banks' recent market share gains might stem more from available cash than strong deposit-gathering abilities.
Global Risks Add Pressure
India's economy is expected to grow between 6% and 6.9% in 2026-2027, showing resilience despite global challenges. Yet, significant pressures persist. The ongoing West Asia conflict continues to push crude oil prices higher, currently around $105 per barrel. Analysts estimate that every $10 per barrel increase in oil prices could widen India's current account deficit by 35 basis points, push inflation higher by 35-40 basis points, and dampen GDP growth by 20-25 basis points. This inflation pressure, along with heatwaves and a potential El Niño event, could push India's overall inflation to an average of 5.6% in FY27, according to HSBC. Such a scenario may prompt the Reserve Bank of India (RBI) to raise its benchmark repo rate, currently at 5.25%, by 50 basis points in two phases, to 5.75%.
Adding to these challenges, foreign investors have significantly pulled back from India. They divested approximately $22 billion from Indian equities in 2026 alone, with total outflows reaching $53 billion since September 2024. This has driven foreign ownership in Indian equities to a 14-year low, falling below domestic institutional investor holdings. Sectors like banking, real estate, and consumer services have seen the sharpest decline in foreign investment. Domestic institutions have absorbed some of this selling, but lower foreign capital makes banking sector funding strategies more complex.
Funding Gaps and Profitability Concerns
While loan growth looks strong, structural funding mismatches and a tough operating environment cast a shadow. Public sector banks, which find it harder to attract deposits than private banks, are concerned about maintaining their Liquidity Coverage Ratios (LCR) while meeting loan demand. Crisil Ratings notes that PSU banks' deposit growth might hover between 9-14%, a figure that could prove insufficient against credit expansion projections. Using more expensive wholesale deposits to fund growth squeezes net interest margins (NIMs), a trend that has reduced profits since 2018, according to McKinsey.
Banks also face closer examination of loan quality, especially for acquisition financing. New RBI rules allowing banks to fund mergers and acquisitions bring complexity and risk, especially given past issues with 'loan evergreening' – artificially extending loan terms to avoid default classification. Geopolitical tensions, rising inflation, and interest rates create further risks, affecting small businesses, exporters, and energy sectors. Many banks, like Axis Bank, are setting aside funds as a precaution against these potential shocks.
Valuation metrics show a split: public sector banks such as Bank of Baroda and Canara Bank trade at much lower P/E ratios (around 6.4x - 6.6x) than Axis Bank (around 15x). This lower valuation likely reflects investor worries about the sustainability of public sector banks' earnings amid tighter liquidity and higher funding costs, despite their market share gains. SBI, while maintaining its 13-15% credit growth forecast for FY27, saw its shares dip nearly 7% following its Q4 earnings release, signaling investor apprehension despite continued optimism on loan expansion.
Outlook: Balancing Growth and Risk
Analysts expect loan growth around 12-14% and deposit growth around 10-12% in FY27, showing a persistent gap banks must manage. Sustaining strong loan growth depends on banks attracting stable, cheaper deposits and managing liquidity amid global economic and geopolitical uncertainty. The sector's performance will be judged not just on loan growth, but on the strength of its funding, its ability to handle rising rates and inflation, and whether it maintains asset quality and profitability.