How To Avoid Credit Bubble 

The Reserve Bank of India expects the Indian economy to grow at 6.5% in 2025-26, underpinned by robust fundamentals. With inflation projected to remain below the medium-term target of 4% in 2025-26, the policy focus has shifted toward supporting growth. 

To foster a conducive liquidity environment, the RBI frontloaded policy easing in June by cutting the repo rate 50 basis points and the Cash Reserve Ratio by 100 basis points.  These moves are intended to boost credit while managing liquidity risks effectively. 

Since April 2025, banks have, on an average, parked around ₹2 trillion in the Standard Deposit Facility . The RBI continues to conduct Variable Rate Reverse Repo auctions, with recent cut-off rates hovering near the 5.50% repo rate. 

The weighted average call rate stayed between 5.26% and 5.34% during July 7–9, close to the SDF rate, indicating ample surplus liquidity. This surplus, currently at around ₹3 trillion, is expected to rise further by ₹2.5 trillion once the CRR cut takes effect between September and December.    

To boost credit flow, banks must strike a balance between credit and market risks, staying aligned with their overall risk appetite to ensure optimal risk-adjusted returns. Deposits remain the main source of lendable funds. However, in recent years, credit growth has consistently exceeded deposit growth. In 2021-22, credit expanded by 19-20% while deposits grew by only 12-13%. The gap widened further in 2022-23, with credit rising 15% and deposit growth slipping below 10%. 

In 2023-24, credit growth held steady at 20.2%, while deposit growth improved to 13.5%. This persistent mismatch prompted banks to realign their funding strategy, manage asset-liability mismatches over the medium to long term. 

As a result, by 2024-25, credit growth declined to 12.1%, while deposit growth lagged 10.6%. As a result, the credit-to-deposit ratio increased from 75% in 2021-22 to 79.6% by May 2025. With the Statutory Liquidity Ratio at 18% and the CRR at 4%, down at 3% by November, CD ratios above 79% raises the market risks, as ALM gaps will need to be bridged through market borrowings. 

Banks manage short-term market risk by aligning with their structural liquidity mismatches across 15 specific time buckets. However, unless long-term deposit growth picks up, banks face considerable risks of ALM mismatches if they use short-term funds to create loan assets. Such ALM mismatches raise exposure to interest rate and liquidity risks. 

While the RBI’s liquidity adjustment facility can provide frictional liquidity to manage market risks, sustained credit expansion must be anchored in durable deposit growth. Excessive reliance on frictional liquidity to fund loan growth beyond the bank’s risk appetite can expose banks to market risks. 

Admittedly, banks are in a strong position with a Capital to Risk-Weighted Assets Ratio of 17% and gross NPAs at 2.6% and net profits of ₹3.71 trillion in 2024-25. Ample liquidity, strong capital adequacy, good asset quality, and rising profitability reflect the emerging robustness of banks but may not translate into lendable resources.   

In a bank-led economy, the flow of steady credit, particularly to the non-corporate sector, is critical for low-ticket borrowers who have no alternative sources of institutional credit. The corporate sector with a good rating has many avenues to meet its financial needs. A balanced sectoral credit deployment, guided by the institutional credit system, is essential to support growth. 

Another concern is the potential decline in incremental deposit growth when low interest rates are passed on to depositors, a process that has already started. Since loans linked to benchmark rates are repriced immediately after the rate cut, the cost of term deposits remains unchanged until they mature, putting pressure on the net interest margins of banks in the short term. To mitigate this, banks will likely transmit interest rate changes on deposits more quickly than reducing the Marginal Cost of Funds-based Lending Rate to minimise the negative impact on NIM.  

Way Forward
To ensure consistent funding, banks must attract deposits by offering differentiated and customer-centric products that cater to tech-savvy youth and senior citizens seeking to balance safety and returns. 

The government should support by raising the deposit insurance above ₹500,000 to boost depositor confidence. Since such reassurance isn't available for other investment options, seniors might prefer to stick with bank deposits to protect their savings.  

Banks may need to go beyond traditional deposit products that are 'one size fits all' and introduce cost-effective digital-only accounts tailored for tech-savvy customers. The lower operational costs of digital-only accounts can be passed on to depositors through slightly higher interest rates. Coordinating closely with the financial and corporate sector can beget institutional deposits, which can form a continuous stream of inflows.

As digital wallets take up more space in retail deposit operations, there will be several young customers such as Gen Z and Gen-Alpha who will demand more customised products. Banks will need to conduct extensive research to understand customer needs and explore new AI tools to build tailored solutions that combine customer satisfaction with operational efficiency. Credit can only increase when sustained deposit growth is maintained through more advanced and nuanced methods. 

Banks must manage credit risk and market risk with appropriate dynamic strategies to stay aligned with the organisation’s risk appetite, which will be subject to scrutiny by the RBI under the risk-based supervision framework. The struggle to balance between market and credit risk will require innovative collaborative strategies to attract deposits and create niche, durable, lendable resources.