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.

India's banking sector has reached a historic milestone with outstanding bank credit crossing the ₹200 lakh crore mark for the first time, driven by robust demand and supportive policy measures. The achievement reflects strengthening economic momentum and increased investment activity across key sectors.

Credit Growth Reaches Multi-Year High

Outstanding bank credit stood at ₹203.2 lakh crore at December-end, registering impressive 14.5% year-on-year growth according to Centre for Monitoring Indian Economy (CMIE) data. This growth rate matches levels last seen on July 12, 2024, indicating sustained momentum in credit expansion.

The year-to-date credit expansion of ₹20.78 lakh crore significantly exceeded the ₹13.18 lakh crore increase recorded in the corresponding period last year. At 11.4%, the YTD credit growth has already surpassed the 11% growth projected for FY26 by the Reserve Bank of India.

Investment Activity Drives Demand

Credit demand is receiving substantial support from increased investment activity, with investment proposals in the first nine months rising to ₹26.62 lakh crore from ₹23.62 lakh crore in the previous year. The growth is being attributed to GST reduction and more accommodative monetary policy measures that have spurred investment activity.

According to Saurabh Bhalerao, associate director and head of BFSI research at Care Ratings, "Credit growth is being driven largely by auto loans, which typically pick up at the end of the calendar year, along with demand from small and mid-sized companies, finance companies and the home loan segment."

Deposit Growth Maintains Steady Pace

Outstanding aggregate deposits reached ₹248.5 lakh crore, showing healthy growth across multiple timeframes. The deposit expansion provides adequate funding support for continued credit growth.

Policy Support and Market Dynamics

The strong credit performance comes after the RBI implemented significant policy measures, including a 50 basis point repo rate cut and a staggered 100 basis point reduction in cash reserve ratio. These measures were introduced after credit growth had fallen to a three-year low of 8.9% year-on-year in May.

Bank of Baroda noted in its report "Investment Climate in 9 Months-FY26" that "there has been a tendency for interest rates to also come down, which is expected to spur investment activity. Hence, the investment environment does appear to be positive in the present financial year."

Data Reporting Enhancement

The credit and deposit data was released following recent amendments to the Banking Regulations Act, 1949, allowing the RBI to publish numbers on the 15th and last day of each month instead of alternate Fridays. This change aims to reduce interpretational ambiguity in market analysis.

Analysts note that if current growth levels are sustained, credit expansion could surpass the 11.5-12.5% forecast by Care Ratings and the 10.7-11.5% projection by Icra, indicating strong momentum in India's banking sector.