Indian Banks Face Funding Squeeze as Credit Outpaces Deposits

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AuthorAkshat Lakshkar|Published at:
Indian Banks Face Funding Squeeze as Credit Outpaces Deposits
Overview

Indian banks are confronting a significant funding challenge as credit growth outpaces deposit mobilization, pushing the credit-deposit ratio to an all-time high of 83.04% as of March 15. Deposit growth stood at 10.8% year-on-year, sharply lagging behind the 13.8% expansion in advances. This imbalance necessitates increased reliance on more expensive wholesale funding and Certificates of Deposit (CDs), raising concerns over profitability and liquidity risk. The geopolitical tensions in West Asia have also contributed to market volatility and foreign investor caution.

Funding Gap Widens to Record High

The Indian banking sector is navigating a critical juncture where credit expansion is consistently outpacing deposit growth. As of March 15, annual deposit growth was recorded at a subdued 10.8%, starkly contrasting with the robust 13.8% surge in advances. This disparity has propelled the credit-deposit (CD) ratio to an unprecedented 83.04%, a level never before seen by the system. This represents a widening gap of approximately 300 basis points compared to the previous fortnight, signaling a fundamental shift in the banking sector's funding structure. Banks are increasingly compelled to tap into more expensive wholesale funding avenues, such as Certificates of Deposit (CDs), which have seen a significant year-on-year increase of 29%. The share of CDs in total deposits has reached 2.6%, the highest in a decade, indicating a growing reliance on non-core funding sources to meet credit demand.

Liquidity Pressures and Profitability Concerns

The sustained high CD ratio directly translates into heightened liquidity risk for financial institutions. Operating with a smaller buffer means banks have less flexibility to manage unexpected outflows or sudden shifts in market sentiment. Analysts warn that this scenario could weigh on banks' profitability, making Net Interest Margin (NIM) recovery delayed and shallower than previously anticipated. While loan growth remains healthy, the cost of funds is escalating due to the increased reliance on costly wholesale deposits and CDs. This dynamic pressures the net interest margins (NIMs), a key determinant of bank profitability, with some forecasts suggesting a delay in NIM recovery until late FY26 or early FY27.

Competitor Benchmarking and Global Context

Globally, credit-to-deposit ratios vary significantly. While advanced economies like Germany and the UK often operate with higher CD ratios due to a greater reliance on wholesale funding, countries like India, China, France, and the US tend to maintain lower ratios supported by robust deposit bases. The current elevated ratio in India, though reaching record highs, is still within a range that, historically, has seen manageable liquidity conditions, but the trend indicates a tightening environment. The average CD ratio for banks globally was around 86.91% in 2021, suggesting India's current level is high but not entirely outside global norms, though the rapid ascent is a point of concern.

The Bear Case: Geopolitical Fallout and Regulatory Scrutiny

The confluence of domestic funding pressures and external geopolitical instability presents a significant bear case for the banking sector. The escalating West Asia crisis has triggered substantial foreign portfolio investor (FPI) outflows, with nearly $6 billion exiting Indian markets by mid-March. This flight of capital adds another layer of caution to market sentiment. Furthermore, rising crude oil prices, a direct consequence of the West Asia conflict, have heightened concerns over India's fiscal position and inflation outlook. This macro-economic backdrop can indirectly impact deposit mobilization and credit demand. The Reserve Bank of India (RBI) has consistently monitored the CD ratio, with statements indicating close observation and readiness to take appropriate measures to ensure banking sector stability. The upcoming implementation of revised Liquidity Coverage Ratio (LCR) norms from April 1, 2026, could also influence deposit strategies, potentially favoring banks with significant wholesale deposits. While the RBI's LCR revisions aim to enhance liquidity resilience, the sustained high CD ratio and reliance on wholesale funding warrants close monitoring from an asset-liability and funding cost perspective.

Future Outlook and Analyst Sentiment

Despite the immediate pressures, analysts like Nomura have warned of margin erosion due to the lagging deposit growth. Moody's Ratings, however, projects a stable outlook for the Indian banking sector, anticipating robust economic growth to underpin solid fundamentals and stable profitability, with loan growth expected to keep pace with deposits in FY26-27. India Ratings and Research expects profitability and margins to improve in FY26-27, contingent on a reversing interest rate cycle and improved retail credit affordability. However, the critical factor remains the ability of banks to attract stable, low-cost deposits to fund expanding credit books without unduly pressuring margins or liquidity buffers.

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