Moneycontrol Pro Panorama | Can banks keep outperforming as deposits flee and lenders lose ground?

A bank basically borrows money from you through deposits and lends it back to you as credit.

Dear Reader,

A stable way to get an exposure to an economy is through its banking sector. This is why a rise in India’s banking stocks has always precluded that of the broader market. In fact, ceteris paribus the Bank Nifty has outperformed the broader Nifty consistently in the past even when small episodes of dubious asset quality have cropped up now and then. 2025 was a similar story and bank shares are running ahead of the market even now.

The reason is simple: Banks have access to household balance sheets. A bank basically borrows money from you through deposits and lends it back to you as credit. Households may shift their money into more lucrative products, but the money would flow back into banks ultimately. Households buying stocks or mutual funds may cause temporary shifts away from banks, but fund houses keep their money with banks and companies, too.

What matters to banks is that a large part of household money must flow to them directly through deposits which is the cheapest way for a bank to borrow and the easiest way to make juicy profits. This is what has been threatened off and on in recent years.

The narrative of Indian banks facing a deposit growth problem is back. The banking sector’s deposit growth has decelerated to 9.05 percent as of mid-December 2025, from about 11 percent a year ago. Indeed, FY26 deposits may grow in single digits or at best 10 percent if the trend continues.

Meanwhile, credit offtake has only increased because of policy measures that boosted consumption and encouraged Indians to borrow more for consumption. Loan growth as of mid-December was 11.8 percent, recovering from the dip to about 10 percent at the beginning of FY26. Credit-to-deposit ratios are high, especially for private sector lenders and it has necessitated borrowings from the market.

Enter margin pressure and profitability under duress. We explored the problems in our banking sector earnings piece here. We observed earlier this week here that interest rates on small savings instruments have been kept unchanged and they pay better than deposits. So, households would prefer to opt for these products than deposits.

In the current fiscal year, the battle for banks is not for loan growth, though it started that way. It is on the liability side of their balance sheet: deposits. Even large lenders such as HDFC Bank and State Bank of India (SBI) would struggle to keep their borrowing costs from rising as they meet demand for cheaper credit from the economy. An easing interest rate regime makes it dicey for banks to manage their margins even more because sticky deposit rates endure more than quickly adjusted loan rates.

Despite all these headwinds on the liabilities side, banks need not worry excessively about it. What they should worry is the loss of market share to non-bank lenders in credit. Giving loans is the primary source of income for a bank and losing lucratively priced loan markets to non-bank finance companies is a concern. Losing wholesale credit opportunities to the bond market should also be a concern.

The Financial Stability Report of the Reserve Bank of India points out that as of November 2025, flow of bank credit to the economy grew by 11.4 percent, but that of non-banks grew at a faster 19.1 percent. Flow of funds from market sources (equity and debt) grew by 21.1 percent. In FY25, flow of banking funds into the commercial sector was down 15 percent while the other sources of funds reported a surge.

Banks are losing their lending business to competitors. Thankfully, the RBI has taken some measures by easing rules wherein banks can participate more in financing deals. Even so, it is important to ponder how banks can arrest this market share loss. If the RBI wants the Indian economy to be bank-led with high financial intermediation involving banks, it must look deeper into prudential norms not just of banks but of other financiers as well.

So far, the regulator is on the right track with easing some rules that needed to be loosened. What it must also do is demand stronger guardrails by non-banks as they grow into significant participants. Meanwhile, banks must re-examine how they underwrite credit.

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Aparna Iyer

Moneycontrol Pro