Despite the deluge of liquidity & lower policy rates, loan growth remains subdued. Banks have been pruning their deposit rates to bring down cost of funds. Nevertheless, in May, non-food credit was up just 8.5% year-on-year. FE explores why credit flows remain muted
l What factors have caused loan growth to slow?
IF SLUGGISH DEPOSIT growth was the story of summer 2024, weak credit growth is fast becoming the story of summer 2025. Loan growth at banks fell two percentage points between March and May, taking the decline between March 2024 and now to 6.3 percentage points. The slowdown in credit flows appears to be the result of a combination of reduced appetite on the part of borrowers and caution on the part of lenders. The slow pick-up in private capital expenditure has left the demand for both project finance and working capital muted. Moreover, given how India Inc is flush with funds— estimated at Rs 13.5 lakh crore in aggregate the need to borrow from banks is now limited.
On the other hand, banks have turned cautious on unsecured lending, having been hurt in sectors such as microfinance. They have also been reluctant to lower their loan rates for corporates for fear of margin pressures.
l Is there ample liquidity in the system?
THE RESERVE BANK of India (RBI) has gone all out to infuse liquidity into the system, just as it had promised. At the end of June, for instance, the durable surplus liquidity in the system was nudging Rs 6 lakh crore. Interest rates at the shorter end of the curve — three months — have come off and the yield on the benchmark bond too has been steady at around 6.30%. The call money rate has been hovering below the repo rate of 5.5% and has just moved up to those levels. In fact, the central bank has been periodically draining liquidity from the system via VRRR — variable reverse rate repo—auctions. At its last monetary policy meeting, the central bank announced that the Cash Reserve Ratio (CRR) would be slashed by 100 basis points. This will free up additional cash to the tune of Rs 2.3 lakh crore for banks.
l Is the slow transmission of policy rate cuts hampering credit offtake?
UNTIL JUNE 6, when the policy rate had been cut by 50 basis points (bps), the loan rates on fresh loans rates had fallen by 6 bps. In contrast, the interest rates on fresh deposit rates had been trimmed by 27 bps. The 100 bps cut in the repo rate has, by and large, been passed on by banks for EBLR loans—external benchmark related loans; typically retail and micro, small and medium enterprises (MSME) credit. However, the MCLR — marginal cost of borrowing funds rate — has come off by just about 20-25 bps on average; this is the rate at which banks lend to companies. Banks have been losing out to the Commercial Paper (CP) and the bond markets; by one estimate, in Q1FY26, the stock of bonds rose Rs 0.5 lakh crore and CPs Rs 1.1 lakh crore. Again, non-banking financial companies (NBFCs) are able to access foreign currency loans at rates lower than bank rates.
l Have banks seen margin pressures?
IN THE JUNE quarter so far, banks have seen a contraction in their net interest margins (NIM) of 17-67 bps. While deposit growth has been higher than loan growth for a couple of fortnights, at around 10% or so, it is nonetheless slower than desired. Most banks have trimmed deposit rates both at the short-end, in terms of savings accounts, and also for term deposits. Savings account rates are now at 2.5% for many banks. State Bank of India, for instance has cut the rate on its 3-5 year fixed deposits by 45 bps from 6.75% in January to 6.3% currently; rates for the 1-2 year tenure have also been cut by 45 bps. The fall has been sharper at 60 basis points for shorter term deposits of 180-210 days. Moreover, borrowings in the wholesale market— via Certificates of Deposit — have become cheaper.
l How soon can the trend in loan growth reverse?
WITH THE BUSY season setting in, in September, and the festive season following thereafter, demand for retail credit is expected to pick up soon. However, the fact is the economy has been losing momentum — GDP has grown at an average of 6.5% y-o-y over the last four quarters compared with 8.5% in the previous eight quarters — and consumer demand remains sluggish. The economy is expected to grow at 6.5% this year.
Consequently, analysts expect bank credit to grow by just 11-12% in FY26 on the back of a growth of 10.8% and 20.4% in FY25 and FY24 respectively. They expect demand for housing and corporate credit to remain subdued. On the back of a growth of 11.5% in FY25, loans to MSMEs are estimated to grow at 10.8-12.8% this year.