KOCHI: Will banks, already facing tight funding conditions, find themselves once again in a race to attract deposits? And will that lead to a renewed rise in deposit rates as the system prepares to fund the next leg of credit expansion?
That question is fast gaining relevance after the Reserve Bank of India (RBI) a few days back unveiled a series of sweeping regulatory changes that significantly ease lending constraints on banks and non-bank lenders.
While these measures aim to improve the flow of credit to the real economy, they simultaneously place pressure on banks to expand their liability base – setting the stage for heightened competition for deposits and a renewed focus on external and capital market funding.
In total, the RBI announced 22 measures, several of which fundamentally widen the avenues through which banks can now deploy credit. These include an enabling framework for banks to fund corporate acquisitions and leveraged buyouts – a space previously out of bounds – removal of the 2016 framework that discouraged large corporate exposures, and relaxation of limits on lending against shares, debt securities, and IPOs.
The central bank also announced plans to rationalise the rules governing external commercial borrowings (ECBs) and allowed greater leeway in issuing overseas perpetual debt instruments that qualify as regulatory capital.
Taken together, the measures represent a structural shift in the regulatory architecture, allowing banks to operate more freely in segments that were earlier restricted or tightly monitored. Banks are bound to make use of this favourable environment and go hunting for fresh liabilities, which may push the deposit rates up further.
Faster credit growth in offing?
But this also implies that banks will need to mobilise significantly more funds to meet the eventual increase in credit demand. For banks already running tight on liquidity, this could lead to a familiar scenario: a scramble for deposits that pushes up the cost of funds system-wide.
For now, the credit-deposit ratio (CD ratio) for the system remains under control. As of July-end, the incremental credit-deposit ratio stood at around 63.7 per cent, while the overall ratio remained below 80 per cent.
Deposit growth has marginally outpaced credit growth in recent quarters. But that balance may prove temporary if the new policy measures translate into higher loan demand across corporate and capital market-linked segments.
Infrastructure financing, promoter stake financing, and deal-backed funding may all see a pick-up as a result of the new flexibilities.
Banks with healthy balance sheets and deep customer franchises may find it easier to mobilise deposits or tap wholesale markets. But others – especially mid-sized and smaller institutions – may have to raise deposit rates more aggressively to compete.
Deposit rates
In fact, deposit rates have already firmed up in recent quarters, with smaller private banks offering up to 7.2 per cent on select term deposits, compared with 6.75–6.80 per cent at public sector banks. The spread between the safest and most aggressive banks has widened to nearly 150 basis points in some cases.
As banks now look to scale up lending under the new framework, several are likely to turn to bulk deposits, certificates of deposit (CDs), and capital market borrowings to bolster their funding base.
Others may tap the external commercial borrowing (ECB) route more actively, given the RBI’s commitment to rationalise end-use restrictions, cost ceilings, and eligibility criteria. Recent deals in the NBFC sector, including Shriram Finance’s $500 million ECB raise, show that there is latent appetite in overseas markets – though cost, hedging and regulatory clarity will continue to matter.
In parallel, banks may also look to bolster their capital base. The RBI has now allowed banks to issue more overseas perpetual debt instruments (Additional Tier 1 or AT-1)) that count towards regulatory capital.
Several public sector banks have already announced plans to raise Tier 1 and Tier 2 capital through bond markets in the coming months. While the deferral of stricter Basel norms and expected credit loss provisions until 2027–31 provides some breathing room, the rising capital needs linked to new credit growth cannot be deferred indefinitely.
Future of NIMs
The risk, however, is that this transition could compress margins if the scramble for deposits becomes too aggressive. With lending spreads unlikely to expand proportionately in a competitive environment, banks may face pressure on net interest margins (NIMs).
At the same time, increased risk-taking – especially in new segments like leveraged deals or equity-backed lending – will test the robustness of credit underwriting and monitoring frameworks.
This is not the first time the banking system has faced a deposit-side squeeze, but what makes the current phase different is that the trigger is regulatory supply-side expansion, not merely cyclical credit demand.
The RBI has effectively signalled that it wants banks to become more active participants in India’s growth story by unshackling legacy restrictions. But with that freedom comes the responsibility of managing funding, capital and credit risk with equal discipline.
Over the next few quarters, the contours of this story will become clearer. Deposit rates may tick higher, wholesale borrowing activity may rise, and select banks may move early to raise capital. The pressure to grow will be balanced by the need to stay prudent.
For now, the stage is set for a fresh chapter in Indian banking – one driven not just by demand, but by newfound regulatory latitude.
