Indian banks are set to witness a 12-14% growth in loans during the 2025-26 financial year, as deposit inflows continue to rise, according to a report by Ambit Capital Research. Despite challenges, the banking sector is showing signs of stability, primarily driven by gradual improvements in loan-to-deposit ratios (LDRs).
Easing Liquidity and Improving Loan-to-Deposit Ratios
The banking sector has had its share of challenges in recent years. Liquidity concerns and asset quality pressures have weighed heavily on loan growth. However, recent trends suggest that the worst may be behind, as deposits have begun to rise steadily, easing some of these concerns. A more manageable pace of loan disbursements has also played a key role in this improvement.
The gradual increase in deposits has led to an uptick in loan-to-deposit ratios (LDRs), providing some relief to the banking system. This improvement is expected to continue into FY26, with experts predicting a stronger outlook for Indian banks. The expectation is that LDRs will stabilize further as deposit inflows grow, and banks become more cautious in their lending practices.
The rise in LDRs is also expected to contribute to a steadier loan growth outlook. As banks face lower pressure on liquidity, they can focus on more sustainable and well-calculated lending practices. This should support steady loan growth through the next financial year, with the possibility of a slight uptick in the pace of disbursements.
Steady Loan Growth Expected Amid Easing Liquidity Conditions
With easing liquidity conditions across the sector, Indian banks are expected to see continued growth in loan volumes. Industry experts are optimistic that the combination of steady deposits and a reduced pace of loan disbursements will keep loan growth between 12-14% for FY26.
This growth is seen as sustainable, underpinned by improving market conditions. The gradual rise in deposit levels will provide Indian banks with the resources needed to meet their lending obligations without compromising the health of their balance sheets. The easing of liquidity conditions will also likely reduce the pressure on banks to raise funds in expensive markets, contributing further to the sector’s overall stability.
Moreover, the possible reduction in risk weights on unsecured retail loans could help fuel further growth, particularly in the retail loan segment. This change, if it materializes, would lower the capital requirements for banks and make it easier for them to lend to consumers. As a result, retail credit could see a boost, which would significantly contribute to overall loan growth in the upcoming fiscal year.
Net Interest Margins May Face Pressure Despite Loan Growth
While the loan growth forecast is optimistic, the report also highlights potential challenges. Despite easing liquidity conditions, banks are expected to face pressure on their net interest margins (NIMs) in FY26. The primary reasons for this include high deposit costs and declining yields.
Banks have been facing higher deposit costs in recent months, as interest rates have risen to attract deposits amid liquidity concerns. At the same time, yields on loans have been falling, which could lead to a squeeze on margins. According to the report, most banks are likely to experience a decline of between 5 to 20 basis points in their NIMs for FY26.
This decline in NIMs is expected to vary across banks, depending on their specific portfolio mix and liability structure. Banks that have a higher share of fixed-rate loans are expected to weather this pressure more effectively. These banks are less exposed to fluctuations in interest rates, which can protect their margins in a high-rate environment.
On the other hand, banks with a larger proportion of variable-rate loans may struggle more, as their interest income could be negatively impacted by the fall in loan yields. These banks will likely face a tougher challenge in maintaining profitability, as rising deposit costs erode their ability to generate attractive returns on their lending portfolios.
Bank Portfolio Mix Plays Key Role in Margin Impact
The impact of declining NIMs will differ based on a bank’s loan portfolio. Banks with a higher share of fixed-rate loans will likely fare better, as their interest income will be less sensitive to changes in interest rates. Fixed-rate loans provide more predictable income streams, allowing these banks to better manage their costs and maintain stability.
In contrast, banks with a larger proportion of variable-rate loans may struggle more, as fluctuations in interest rates could reduce their loan yields. With falling yields, these banks might find it more difficult to achieve strong returns on their lending portfolios, which could further pressure their margins.
The ability of banks to manage these challenges will be critical as they navigate the financial year ahead. While loan growth is expected to be strong, maintaining profitability in the face of margin pressures will require strategic adjustments. Banks may need to focus on diversifying their portfolios, improving efficiency, and managing costs to mitigate the impact of falling yields.
Sector Outlook and Key Drivers
Looking ahead, the outlook for Indian banks in FY26 remains positive, despite the challenges they may face with net interest margins. Several factors are expected to drive the sector’s growth, including:
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Continued Deposit Growth: With easing liquidity conditions, deposit inflows are expected to remain steady, providing banks with the necessary resources to fuel loan growth.
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Retail Loan Growth: If the risk weights on unsecured retail loans are reduced, banks could see significant growth in this segment, which has been a key driver of overall loan growth in recent years.
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Easing Regulatory Pressures: The easing of regulatory requirements and risk weights could provide additional leeway for banks to expand their lending operations without increasing capital requirements.
The combination of these factors sets a strong foundation for continued loan growth, even as banks face challenges with margins. The sector’s ability to adapt to these pressures will play a pivotal role in maintaining its positive outlook in the coming fiscal year.
