MUMBAI: The easing in some of the key regulations since the new governor Sanjay Malhotra took office in December can help banks, which have been seeing lower credit sales due to as well as higher interest rates, bolster their loan books expansion to the tune of 10.8% in FY26, says a report, adding their net interest margins will decline by 15-17 bps due to falling interest rates but high deposit pricing.
Rating agency Icra while maintaining a positive outlook for the banking sector on Tuesday has however warned of the rising delinquencies saying “asset quality remains a monitorable factor requiring close observation amid evolving economic conditions.”
At 10.8% incremental credit is projected at Rs 19-20.5 trillion in FY26. Till the fortnight ending March 21, credit grew at 11% to reach Rs 182.4 trillion, down 16.3% a year go, while deposits grew by 10.3% to Rs 225.7 trillion, down from 12.8% a year ago.
The agency expects the regulatory easing seen in the recent months to support a credit expansion of 10.8 % in FY26. Such measures include the repo rate cut, deferment of proposed changes in the liquidity coverage ratio (LCR) framework and additional provisions on infra projects, along with the roll-back of increased risk weights on lending to unsecured consumer credit and non-banks.
Besides this, the durable liquidity infusion by the Reserve Bank through open market operations (OMOs) and forex swaps with banks, will also aid liquidity and faster transmission of the ongoing cut in policy rates.
Nevertheless, the persisting challenges in deposit mobilisation, high credit-deposit (CD) ratio and rising stress in the unsecured retail and small business loans will remain a drag on credit growth and accordingly the pace of credit expansion is expected to trail the recent highs seen in FY24, the agency warned.
Sachin Sachdeva, a vice-president & sector head at the agency said, the pro-growth regulatory stance has revived the lenders’ appetite for credit growth in Q4 after a brief period of slow incremental credit growth in the initial period of FY25. Accordingly, we estimate the incremental credit expansion to be around Rs 19-20.5 trillion, clocking a growth rate of 10.8% in FY26 compared to credit expansion of Rs 18 trillion or 10.9% growth rate in FY25.
He also said the recent liquidity injections are likely intended to nudge a faster transmission of rate cuts. But one of the key challenges, which the banking sector has been facing in the last few years is raising deposits at competitive pricing, especially the retail deposits, given the pressure on the LCR. The increasing competition from other investment avenues and the investors’ preference for term deposits have led to a reduction in the share of low-cost Csas balances, impacting their fund cost. The challenges are likely to persist in the near term, which is likely to delay the transmission of rate cuts by the RBI to banks’ cost of funds, in spite of the recent liquidity measures, thereby impacting the banks’ margins.
With an elevated CD ratio, the competition for deposit mobilisation is likely to remain high even during FY26 too, which will limit the banks’ ability to cut their deposit rates. The lending rates may, however, remain under pressure because of the decline in the external benchmark-linked loans and competition from debt capital markets, he said.
With expectations of a cumulative 75 bps cut in the repo rates from February onwards, we expect net interest margins to decline by 15-17 bps during FY26, Sachdeva added.
Asset quality remains monitorable amid broader macroeconomic developments and the fresh NPA generation rate is expected to rise in the next few quarters, while the recoveries and upgrades are likely to moderate. Consequently, the quantum of gross NPAs and credit loss provisions would rise, although the GNPA is estimated to remain range-bound by March 2025 and rise in FY26.
Though we expect the profitability to trend downwards in FY26 with the return on assets and return on equity at 1.1-1.2% and 12.1-13.4% respectively, the same are estimated to remain comfortable for the projected growth without a significant reliance of fresh capital requirements, leading to a stable outlook for the sector, he added.