Whalesbook
Public sector banks (PSBs) are seeing their liquidity buffers shrink, raising concerns about future loan growth. With new credit loss rules expected to increase costs and private sector lenders intensifying competition, the banking landscape is shifting. Investors are now watching how PSBs manage deposit growth versus their private counterparts.
What Happened
Public sector banks (PSBs) in India are entering a more challenging phase as the easy liquidity that fueled their recent growth begins to dry up. For the past few years, these banks benefited from ample liquidity and low credit costs, which allowed them to expand their loan books aggressively. However, recent data indicates that this period of rapid expansion may be slowing down due to tighter liquidity and rising operational costs.
The Liquidity Challenge
At the heart of this shift is the Liquidity Coverage Ratio (LCR), a critical metric that shows whether a bank has enough high-quality assets to survive short-term cash outflows. Recent figures show that the LCR for public sector banks dropped from 137% in April 2025 to 123% by March 2026. This decline means that PSBs have fewer spare liquid assets available to support new lending. Consequently, these banks can no longer rely on selling existing investments to fund loans; they must now shift their focus to attracting fresh customer deposits to grow.
Rising Credit Costs
The business environment is set to get tougher with the upcoming introduction of the Expected Credit Loss (ECL) framework. Unlike the current system, where banks set aside money for bad loans after they occur, the ECL model requires banks to estimate potential future losses and set aside capital in advance. This change is expected to increase provisioning costs, which directly affects bank profitability. While this is a prudent regulatory move to strengthen the banking system, it will likely create temporary pressure on the earnings of public sector lenders.
Shifting Competitive Landscape
The competitive dynamic between public and private banks is also evolving. Large private sector lenders, including HDFC Bank, have spent the last year navigating merger-related integration. As these private entities stabilize and resolve their internal challenges, they are expected to become more aggressive in capturing market share. For investors, this suggests that the era where PSBs easily gained market share from private peers may be coming to an end, with private banks poised to step up their growth.
A Balancing Factor
While the outlook for liquidity is tightening, the Reserve Bank of India has provided some relief through its special Foreign Currency Non-Resident (B) deposit scheme. This initiative, which absorbs hedging costs, could help inject liquidity into the domestic system, providing some support to both public and private banks during this transition.
What Investors Should Monitor
Investors may want to keep a close watch on deposit growth rates, as the ability to mobilize deposits will now be the primary driver of loan growth. Other monitorables include the movement of CASA (Current Account Savings Account) ratios, which indicate the cost of funds, and any commentary from management regarding the impact of the new ECL provisioning on net profit margins. The relative growth speed of private banks compared to PSBs will also be a key trend to track in the coming quarters.