Credit growth outpaces deposits, pushing banks’ CD ratio to 85%: BCG

India’s banking sector continued to see credit growth outpace deposit mobilisation in the first quarter of FY27, putting further pressure on liquidity even as margins recovered from the compression witnessed in FY26, according to Boston Consulting Group’s (BCG) Q1FY27 Banking Sector Round-up.

Bank advances grew 18% year-on-year, compared with 12% growth in deposits, pushing the credit-deposit (CD) ratio to 85%. However, a rise in lending rates and a moderation in deposit rates supported a recovery in net interest margins (NIMs) across bank categories.

Lending rates increased 13 basis points since March 2026, while deposit rates declined 8 basis points, helping banks offset the impact of faster credit growth.

Despite the improvement in margins, the industry’s cost-to-income ratio (CIR) deteriorated by 54 basis points year-on-year to 47%. Fee and other income declined faster than operating expenses, even as operating expenses relative to assets fell.

Asset quality stabilises, credit costs decline

Improvement in asset quality showed signs of flattening, with the gross non-performing asset (GNPA) ratio remaining at the FY26 level of 1.7%. However, this was lower than 2.2% in the year-ago quarter.

Credit costs declined 31 basis points year-on-year to 0.3%, supporting a 16% growth in profit after tax (PAT), despite a 13% decline in other income.

AI adoption expands, but governance gaps persist

Generative artificial intelligence (GenAI) adoption has gained traction across the banking sector, with 86% of banks implementing GenAI use cases, nine times the level recorded in 2024, according to the report.

However, governance frameworks have not kept pace with adoption. Only 33% of banks have board-level oversight of AI, while 18% maintain audit logs and 14% conduct real-time monitoring for model drift.

The gaps highlight the need for stronger controls as banks scale up AI deployment. The Reserve Bank of India’s new Model Risk Management framework is aimed at strengthening oversight of risks associated with the use of such models.

FCNR(B) measures boost liquidity, but repayments loom

The RBI’s measures to attract foreign currency non-resident bank (FCNR(B)) deposits, including hedging support, rate-cap changes and cash reserve ratio (CRR) and statutory liquidity ratio (SLR) relief, mobilised $127.2 billion as of September 2026, around five times the amount raised during the 2013 window. The inflows helped push the banking system’s liquidity surplus to ₹9.7 lakh crore, a four-year high.

However, repayments are concentrated in the 2029-31 period, creating a potential liquidity challenge for banks. While the RBI bears the currency risk under the framework, banks continue to carry the interest cost, leaving them exposed to the implications of concentrated repayment obligations.

UPI moves towards merchant-funded model

The Unified Payments Interface (UPI) is shifting towards a merchant-funded model, with a merchant discount rate (MDR) of 0.4% on person-to-merchant (P2M) transactions above ₹2,000 expected to help fund the payment system’s annual resilience and cybersecurity costs of around ₹20,000 crore.

Person-to-person (P2P) transactions and payments involving small merchants will continue to remain free, according to the report.

Credit growth outlook remains positive

BCG expects credit growth to remain in the high teens in FY27, supported by GST cuts, government capital expenditure and the Emergency Credit Line Guarantee Scheme (ECLGS) 5.0.

Easing funding costs are also expected to provide further support to banks’ NIMs. However, asset quality in the micro, small and medium enterprises (MSME) segment and the risk of higher oil prices amid geopolitical tensions in West Asia remain key monitorables.

The report flagged West Asia-related risks, given the region’s significance for India’s trade, estimated at 14-20%, as a factor that could affect the broader economic and banking outlook.