India Ratings lifts bank credit growth forecast, but warns of margin pressures

Mumbai: India Ratings and Research has raised its banking-sector credit growth forecast to 15% for the current financial year from 13% earlier, but warned that the current pace of expansion is unlikely to be sustained amid elevated loan-deposit ratios (LDR), pressure on profitability, and higher credit costs emerging as key risks.

The rating agency maintained a neutral outlook on the banking sector, saying the latest 19.3% year-on-year credit growth is being driven largely by lower-yielding corporate and non-bank finance company (NBFC) loans rather than a broad-based acceleration in lending. The deposit growth was 15.4% as of 31 July.

“…high LDR in the banking system, at about 85%, along with moderated profitability, resulting in muted net interest margins, and an expected year-on-year increase in credit costs, are near-term concerns,” Karan Gupta, head and director, financial institutions at India Ratings, told reporters.

The agency expects the 19% credit growth pace to moderate in the second half of FY27 as the current drivers lose momentum. Large corporate loans, which account for about 16% of the banking system, have accelerated to around 15-16% from 2-3% last year, largely reflecting working-capital demand. Meanwhile, bank lending to NBFCs is growing at around 32%, helped by tighter bond-market yields that have made bank funding relatively more attractive.

However, the growth mix is margin-dilutive. Higher-margin unsecured retail credit has slowed sharply, with growth at 12.3% in June 2026 compared with 25% in January 2024. India Ratings expects loan growth to normalize towards 15% as banks face pressure on profitability.

The key structural problem remains deposits. Deposit growth has lagged credit growth by an average 380 basis points since FY22, pushing the LDR to 84.8% in the June quarter from 71.7% in FY22.

While the Reserve Bank of India’s relaxation of foreign currency non-resident bank or FCNR(B) deposits is expected to bring in additional funds and temporarily ease LDR pressure, the rating agency cautioned that it does not resolve the underlying structural shortage of deposits.

The agency has raised its FY27 deposit growth forecast to 13.6% from 11.4%, primarily because of FCNR(B) inflows. Beyond the temporary boost, banks will still need to compete aggressively for deposits and increasingly rely on certificates of deposit and bulk deposits, raising funding costs.

Profitability is expected to remain under pressure. The agency forecasts system-wide credit costs at 74 basis points in FY27, up from 65 basis points in FY26, partly reflecting the transition to expected credit loss (ECL) provisioning. System-wide return on assets is consequently projected to decline by 6 bps to 1.31%.

The agency does not see a meaningful asset-quality problem in banks at present. Gross non-performing assets are below 0.5% and corporate borrowers have yet to show broad-based signs of stress. The bigger concern is that banks are generating growth at lower returns.

On NBFCs, the agency retained a neutral outlook and expects overall growth of 15-16% in FY27, with larger, well-capitalized players growing around 20%. Asset-quality risks are concentrated in commercial vehicles, micro-loans against property (LAP) and unsecured lending. In commercial vehicles, erratic monsoons, fuel-cost pressures, and freight-rate volatility could weaken borrowers’ cash flows and increase stress.

Micro-LAP remains particularly vulnerable because of overlap with microfinance borrowers and difficulties in enforcing collateral in smaller cities, potentially resulting in higher loss-given-defaults.

Gold loans remain broadly stable because they are secured, but rapid expansion is driving operating costs, including increased spending on fraud prevention, security and experienced manpower. Rising loan-to-value (LTV) ratios on income-generating gold loans also remain a monitorable because a sharp correction in gold prices could trigger additional collateral requirements and more auctions.