Subdued Credit Growth on the Horizon for India's FY26 Economic Prospects: Report Certificates of deposit, which reached a decadal peak of INR 4.9 trillion as of November, 2024, reflect this dynamic. While this figure surpasses the previous high of INR 4.5 trillion recorded in April 2011, the share of total deposits remains modest at around 2.5 per cent

The Indian banking sector's credit growth is estimated downwards to 10.5-11 per cent for FY2025, compared to its earlier projection of 11.6-12.5 per cent. In a recent report, ICRA revised its credit growth estimates for the sector. The revision reflects a combination of structural adjustments within the banking system and broader economic factors. Banks have been actively working to align their credit-to-deposit (CD) ratio, while also reducing exposure to unsecured retail loans and non-banking financial companies (NBFCs). These efforts, though essential for long-term stability, have led to a moderation in credit growth.

Sachin Sachdeva, vice president and sector head for financial sector ratings at ICRA, highlighted that banks are now focusing on reducing high-yielding advances, which, combined with persistently high interest rates, is impacting margins. "The rate transmission on yields is estimated to be faster as and when the rate cut cycle begins, which would further compress the margins," Sachdeva noted. Despite these challenges, the banking sector is expected to maintain healthy return indicators, with return on assets (RoA) projected at 1.2-1.3 per cent for FY2025 and 1.1-1.2 per cent for FY2026, compared to 1.3 per cent in FY2024.

Slower credit growth and challenges

The alignment of credit and deposit growth trends is expected to persist, with the report forecasting credit growth to ease further to 9.7-10.3 per cent in FY2026. This moderation is attributed to the continued high CD ratio and the anticipated implementation of the revised liquidity coverage ratio (LCR) framework, which is expected to put additional pressure on liquidity.

Raising deposits remains a challenging and costly proposition for banks, driven largely by the growth in term deposits. Certificates of deposit, which reached a decadal peak of INR 4.9 trillion as of November, 2024, reflect this dynamic. While this figure surpasses the previous high of INR 4.5 trillion recorded in April 2011, the share of total deposits remains modest at around 2.5 per cent, compared to a peak of 8 per cent in the past.

In response to these challenges, banks are increasingly turning to bond issuances to bolster their funding. Bond issuances by banks are projected to hit INR 1.3 trillion in FY2025, surpassing the INR 1.02 trillion issued in FY2024. This shift underscores the growing importance of capital markets in addressing the funding needs of the banking sector.

The asset quality of banks has steadily improved in recent years, with net additions to non-performing advances (NPAs) remaining low. However, the retail sector is beginning to show signs of stress, which is expected to lead to a gradual rise in fresh slippages. The gross fresh NPA generation rate for all banks is forecast to increase slightly to 1.6 per cent in FY2025 from 1.5 per cent in FY2024, though still significantly lower than the 2.0 per cent in FY2023 and 3.1 per cent in FY2022.

Credit costs, which are estimated to account for 21-23 per cent of the banking sector's operating profit in FY2025 and 27-30 per cent in FY2026, remain manageable, particularly when compared to the 100-150 per cent levels seen between FY2018 and FY2020.

Banks' capital positions remain robust, with no major growth-related capital requirements expected for FY2026. However, the implementation of the expected credit loss (ECL) framework and increased provisioning for project finance pose potential risks.