Liquidity situation in the banking system is expected to improve in the fourth quarter, driven by an increase in government spending, said India Ratings and Research.
The rating agency believes 2025-26 to be a year of headwinds, leading to market volatility and moderately tight financing conditions. Key headwinds will include externalities, length & breath of indebtedness in the retail lending space, volatile banking system liquidity and domestic growth-inflation conundrums.
“In the milieu of external headwinds and weakening domestic credit conditions, the overall credit market is expected to see higher volatility and elevated spreads, especially for the entities with a weak credit outlook,” Soumyajit Niyogi, director – core analytical group, India Ratings and Research (Ind-Ra). “Given limited tailwinds from the monetary and fiscal space and cautious financing conditions, easing of banking system liquidity on a sustained basis and timely availability of risk capital have become critical.”
Liquidity situation in the banking system eased in the first week of this month. After reaching Rs 1.04 lakh crore on January 1, the deficit in the banking system remained below the Rs 1-lakh-crore mark till January 6. However, the deficit breached the mark on January 7 and reached Rs 1.44 lakh crore. According to the RBI data, the deficit hit Rs 1.81 lakh crore on January 8.
“Amid multiple headwinds and weak macro and micro conditions, a sustained easing of the banking system liquidity is necessary. The uncertain outlook on near-term domestic growth and unstable global operating and financing environment do not augur well for financing conditions, especially for the financial sector,” Niyogi said. “Amid this scenario, stable surplus liquidity is warranted, not only for easing the pressure on bank’s lending rates but also to ensure ease of financing.”
The rating agency believes the deposit rate in the banking system has peaked. However, the structural shift in the system will keep the downward rigidity intact. As a consequence, banks’ lending rate is expected to elevate in FY26, barring modest softening from the second quarter.
The agency believes large and frequent volatility in the banking system liquidity does not augur well for financing conditions, especially when the overall environment is not so favourable. The high volatility in the banking system liquidity also acts as a deterrent for commercial banks in terms of addressing adverse loan-to-deposit ratios and asset liability pricing.