MAGNIFIED PRESSURE

While the asset quality of banks is anticipated to remain largely stable, challenges persist in the form of mobilizing deposits and peaking profitability

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The 50-stock Nifty index has given returns of over 25% in the past one year, but the banking sector (represented by the 12-share Bank Nifty) has lagged behind with a growth of only around 12%. This underperformance stems from investor nervousness about the sector’s profitability.

Concerns about bank profitability have emerged due to a mismatch in deposit and credit growth. Data from the Reserve Bank of India (RBI) shows a significant imbalance. By mid-March, deposits in the banking system grew at a moderate pace of around 13% to ₹205 lakh crore. However, lending grew at a much faster rate of 20%, reaching ₹164.3 lakh crore. This has pushed the credit-to-deposit (CD) ratio to a 10-year high of 80%, up from 75% in fiscal year 2012-22. The rise in loans is primarily driven by personal loans and the services sector.

A high credit-to-deposit (CD) ratio indicates banks are lending a larger portion of their deposits. This increases liquidity risks because there is less buffer to handle unexpected withdrawals. Currently, attracting new deposits is expensive for banks. To save margins and maintain profitability, banks ideally want to raise interest rates on loans. However, this might be difficult in the current economic climate. The other option is to limit loan growth, which could hinder future expansion and disappoint investors.

THE CONTEXT