Banks gain liquidity from FCNR deposits but face near-term margin pressure

The surplus liquidity has eased funding constraints for lenders, allowing them to sustain loan-book expansion amid strong credit demand. However, banks are deploying these funds slowly into higher-yielding assets, leaving surplus parked in lower-yielding short-term instruments, which creates a negative carry and weighs on margins.

Analysts at Motilal Oswal Financial Services expect private-sector bank NIMs to decline by 8-20 basis points in the September quarter, while Nomura Global Markets Research anticipates continued margin pressure as banks hold FCNR(B)-linked liquidity in low-return assets until deployment into loans improves.

Public-sector banks are projected to show more resilient and range-bound NIMs, as FCNR(B) deposits form a smaller share of their deposit base and they continue retiring high-cost liabilities. System credit grew over 18% year-on-year as of 15 September, with deposits rising more than 17%, narrowing the credit-deposit gap and pushing the system credit-to-deposit ratio down to 81% from 82% in August.

FCNR(B) flows have accelerated system deposit growth to 17% from an earlier 11-12%, contributing about 4.5% of total deposits. The banking system's liquidity surplus peaked at ₹9.85 trillion on 15 September before easing to ₹4.7 trillion by 30 September, according to Nomura, with the RBI absorbing some excess through operational measures.

Motilal Oswal forecasts FY27 credit growth at around 15.5%, supported by retail demand, MSME utilisation, corporate borrowing, and FCNR(B) inflows. Nomura expects high-teens loan growth in the second quarter, with margins under pressure during the transition period.

Among mid-sized private banks, RBL Bank may see NIM expansion from the full-quarter effect of Emirates NBD Bank's capital infusion, while IDFC First Bank is likely to face a sharper sequential NIM decline. A potential repo-rate hike later this week could support NIMs, particularly for banks with higher floating-rate loan exposure.

Despite margin pressures, analysts expect strong loan growth to drive healthy earnings. Motilal Oswal estimates private-bank profit to rise 24% year-on-year in the September quarter, compared to 27% for PSU banks, with overall banking sector profit projected up 25% year-on-year and 9.5% sequentially. Asset quality remains benign, with slippages and credit costs expected to stay under control, though risks persist from uncertain macroeconomic conditions and below-normal monsoon.