India's banking sector has witnessed substantial transformation over the past two decades, with the credit-deposit ratio climbing from 53% in 2000-01 to 82% as of December 15, 2024, according to an SBI Research Report released on Monday, January 12. This upward trajectory reflects the ongoing financialisation of the economy and signifies better financial development leading to strong economic growth.

Banking System Scale Expansion

The Indian banking system has demonstrated remarkable scale expansion during FY05–FY25, with both deposits and advances growing manifold over this period.

The incremental credit-deposit ratio numbers crossed 100% in multiple instances, demonstrating increasing demand for credit despite lean deposit growth. Banks honored this demand by raising resources from alternative sources, highlighting the sector's adaptability and resourcefulness.

Post-Pandemic Recovery and Market Dynamics

Indian banks have exhibited strong post-pandemic balance sheet revival, with bank asset growth rebounding sharply to 94% of GDP compared to 77% in FY21. This recovery reflects renewed credit intermediation and financial deepening across the banking sector. The credit-deposit ratio specifically increased from 69% in FY21 to 79% in FY25, demonstrating accelerated lending activity.

Public Sector Banks have shown continued revival after experiencing secular decline since FY08. PSBs are gradually reclaiming market share, indicating successful balance sheet repair and renewed lending appetite. From a peak of 71% market share in FY08, PSBs experienced decline in both deposits and advances, but recent data suggests they are recovering their advances market share.

Sectoral Trends and Employment Growth

CASA (Current Account Savings Account) stability has masked divergent trends across different bank groups. While overall CASA ratios remained around 37%, private banks strengthened their CASA shares whereas foreign banks witnessed erosion in this segment.

Unsecured advances have expanded significantly from ₹2.00 lakh crore to ₹46.90 lakh crore, with their share rising to 24.50% in FY25 from 17.70% in FY05. PSBs accounted for half of the unsecured lending, followed by Private Sector Banks.

Banking employment nearly doubled over two decades, with the officer share rising from 36% to 76%, indicating skill intensification and preference for higher-value roles within the sector.

Asset-Liability Management Challenges

The report identified a gap between the maturity profile of deposits and advances, particularly in the 6 months to 1 year and 1-3 year time buckets. The 35% share of advances in the 1-3 years bucket indicates an increasing tendency of pre-payment among borrowers, presenting asset-liability management considerations for banks.

Indian banks are sitting on their strongest balance sheets in more than a decade, marking a significant milestone in the sector's recovery and growth trajectory. According to Krishnan Sitaraman, Chief Ratings Officer at Crisil Ratings, the overall health of the banking system has reached exceptionally strong levels by historical standards. However, emerging risks in credit-deposit dynamics and selective sector stress are creating new monitoring priorities for the industry.

Unprecedented Balance Sheet Strength

The banking sector's financial indicators present a remarkably positive picture across multiple metrics. Key performance parameters including gross non-performing assets, provisioning coverage ratios, capital adequacy, and liquidity coverage ratios have all reached comfortable levels. Sitaraman emphasized the historical significance of this achievement, stating that current balance sheets represent "perhaps the strongest that I've seen in the last 15 years or so."

Critical Risk: Widening Credit-Deposit Gap

Despite the strong fundamentals, a significant structural risk has emerged in the form of diverging credit and deposit growth rates. The data reveals a concerning trend in recent months:

This mismatch has driven the loan-to-deposit ratio to an all-time high, creating what Sitaraman describes as "a key monitorable for the banking system." The gap had temporarily narrowed during the first quarter of the fiscal year but has since widened again as credit growth accelerated.

Drivers Behind Credit Surge

The robust credit demand stems from multiple policy and macroeconomic factors that have collectively boosted consumption patterns. Key drivers include:

• Goods and Services Tax (GST) rationalization
• Income tax cuts
• Lower interest rates
• Benign inflation environment

These factors have particularly strengthened retail and MSME credit growth, contributing to the overall credit expansion in the system.

Banking Sector Response and Strategy

In response to the elevated loan-to-deposit ratio, banks are adopting more cautious and selective lending approaches. The industry is witnessing a clear strategic shift towards secured loans as institutions manage their risk exposure. Additionally, some banks are exploring securitization transactions as a balance sheet management tool, following the precedent set by a large private bank in the previous fiscal year.

MSME Sector: Early Warning Signals

While the broader asset quality outlook remains stable, Crisil has identified specific areas of concern within the MSME segment. The agency notes that MSMEs typically experience stress first when credit cycles turn, due to their relatively weaker financial resilience compared to large corporates. Export-oriented sectors with US market exposure are facing particular headwinds:

• Gems and jewellery
• Home textiles
• Marine foods

These segments are experiencing pressure due to the current tariff environment, though Sitaraman expects the stress to remain contained rather than becoming systemic.

Asset Quality Projections

Crisil's projections for the current fiscal year indicate a measured increase in non-performing assets. The agency expects NPAs to reach approximately 3.9% by fiscal year-end, representing an increase of 20 to 30 basis points over the course of the fiscal year. This represents a modest rather than sharp deterioration, with increases expected in specific pockets and sectors rather than across the system.

Outlook and Key Monitoring Areas

While Indian banks enter this phase with unprecedented balance sheet strength, the sustainability of this position will depend on how effectively the industry manages emerging challenges. The evolving credit-deposit dynamics and selective MSME stress will serve as key determinants of the sector's continued resilience. Banks' ability to navigate these risks while maintaining their strong fundamentals will be crucial for preserving the sector's current robust health.