Indian Banks: Profit Squeeze Amidst 18% Credit Growth

Indian banks are experiencing robust credit growth, which accelerated to 18% by late June, yet this expansion is not translating into a corresponding increase in their earnings. Profitability is under pressure due to rising operational costs, primarily linked to funding challenges.

The surge in lending, which doubled from 9% a year prior, is largely fueled by corporate credit. This indicates increased business spending and new projects, generally a positive sign for the broader economy.

Understanding the Funding Challenge

Banks’ ability to expand their net interest income is constrained by the slow growth of Current and Savings Account (CASA) deposits. CASA deposits represent the cheapest source of funds available to financial institutions.

• Credit growth reached 18% by late June.
• This rate doubled from 9% recorded a year prior.
• High-cost funding is expected to impact margins through fiscal year 2027 (FY27).

Insufficient CASA growth compels banks to seek more expensive bulk funding to meet the strong corporate demand for loans. This results in a high-cost funding mix that impacts their net interest margins (NIMs).

Regulatory Adjustments and Future Outlook

This high-cost funding is projected to continue impacting net interest margins throughout fiscal year 2027, despite aggressive lending efforts. Net interest margins measure the difference between the interest banks earn on loans and the interest they pay on deposits.

The Reserve Bank of India (RBI) is closely observing these developments while maintaining a supportive stance for the economy. Instead of focusing on high loan-to-deposit ratios, the RBI has prioritized liquidity management tools.

Since April, the RBI has adjusted Liquidity Coverage Ratio (LCR) norms, providing banks with greater flexibility to continue their lending activities. These regulatory adjustments aim to ease constraints on bank liquidity.

Investors are advised to monitor banks’ deposit acquisition strategies closely in the coming quarters. An improved funding mix will be crucial for stabilizing margins and enhancing bottom-line performance.