Credit Surge Tests Banks’ Liquidity Defences and ALM Discipline

Credit growth is pulling away from deposit growth, creating a funding challenge for banks. In 2025-26, credit grew 15.9% against deposit growth of 13%. The gap has widened further in the current year. As on May 31, credit growth stood at 17.7%, while deposits grew only 12.2%, leaving a 550-basis-point differential.

Outstanding bank credit increased by ₹1.5 trillion to ₹215.2 trillion. The credit-deposit ratio consequently rose to 82.8%, a level that warrants close attention from a liquidity management perspective.

Banks have bridged the funding gap through a combination of higher Certificates of Deposit issuances, drawdown of surplus Statutory Liquidity Ratio and Liquidity Coverage Ratio buffers, and lower investment in government securities. Deposit mobilisation has increasingly come from term deposits, which grew 10.6%, adding to funding costs.

Liquidity conditions may appear comfortable on the surface. The weighted average call rate remained between 5.22% and 5.28% during April and May 2026, comfortably within the policy corridor. Yet the pressure is visible in the CD market. The one-year CD rate has moved up to 6.70%, while outstanding CDs have risen from about ₹8 trillion in 2023-24 to nearly ₹14 trillion in last fiscal. The growing recourse to CDs is perhaps the clearest indication that deposit growth is not keeping pace with credit demand.

The impact is already visible in margins. Net interest margins declined from 3.46% in March 2025 to 3.26% in March 2026. With banks paying more for deposits and wholesale funds, margin pressure is likely to persist through 2026-27. Several banks have already raised their MCLR by 5-10 basis points to reflect higher funding costs.

The drivers of credit growth reveal the broad-based nature of demand. Credit growth stood at 33.1% for MSMEs, 21.7% for medium enterprises and 16.2% in the personal loan segment, largely led by housing finance. Higher credit utilisation by oil marketing companies amid rising crude prices and rupee depreciation, coupled with lending under ECLGS 5.0 and enhanced CGTMSE-backed credit flows, has further accelerated credit growth.

Hidden Exposure
An often overlooked aspect of liquidity management is the gap between credit sanctioned and credit actually availed. Sanctioned limits represent committed lines of credit, while availed credit reflects actual drawdowns. Corporate borrowers typically utilise only 65-70% of approved limits.

This means that 30-35% of sanctioned credit remains undrawn. As of March 2026, the unavailed credit pool is estimated at ₹40-50 trillion. While not immediately reflected as funded assets, these facilities represent contingent liabilities for banks and contingent liquidity for borrowers.

The risk becomes evident during periods of stress. Borrowers can draw down these limits at short notice, increasing funding requirements for banks already operating with tighter liquidity conditions. Similarly, non-fund-based facilities such as letters of credit and bank guarantees can be invoked, creating immediate funding obligations.

Banks therefore need to strengthen monitoring of undrawn commitments and non-fund-based exposures. Unless these contingent risks are integrated into ALM frameworks, liquidity pressures can emerge suddenly and prove difficult to manage.

Strategic Responses
The Reserve Bank of India's recent decision to permit greater flexibility in pricing bulk deposits offers one tool for managing ALM mismatches. Bulk deposits are now defined as single-rupee term deposits of ₹30 million or more, compared with the earlier threshold of ₹20 million.

This flexibility enables banks to adopt dynamic pricing linked to liquidity conditions. If a bank experiences a sudden rise in loan drawdowns within a particular maturity bucket, it can selectively raise rates for deposits of matching tenor to attract funds quickly. Such duration-matched funding is more efficient than raising retail deposit rates across an entire branch network. Non-callable deposits can further improve funding stability.

Another important development is the RBI's FCNR(B) package announced in the June 5 monetary policy statement. By allowing banks to offer higher interest rates on new three- to five-year FCNR(B) deposits until September 30, 2026, the RBI has created an incentive for fresh overseas inflows. Some analysts estimate that banks could attract more than $50 billion through these deposits.
Previously, a 4% interest rate on a US dollar FCNR(B) deposit could translate into an effective funding cost of around 7.5% after hedging expenses. 

The RBI's specialised dollar-rupee swap window substantially reduces this burden. Since these deposits are exempt from CRR and SLR requirements, they provide readily deployable resources for lending.

Banks must also intensify efforts to mobilise retail deposits through product innovation. Tailored schemes for high-net-worth individuals and senior citizens, special-tenor deposits and infrastructure bonds can help diversify funding sources and improve resource stability.

Securitisation offers another useful option. By pooling home loans, vehicle loans and MSME loans into pass-through certificates sold to institutional investors, banks can release liquidity without constraining fresh lending. Every ₹1 trillion of loans securitised effectively frees up resources equivalent to mobilising ₹1 trillion of deposits.

Banks should also maximise refinance facilities available through NABARD, SIDBI, NHB and Exim Bank, alongside government-supported schemes such as Mudra and Pradhan Mantri Awas Yojana. The sale of non-performing assets to asset reconstruction companies and NARCL can also release funds and improve balance-sheet efficiency.

However, liquidity management cannot depend indefinitely on CDs, special deposits, securitisation and regulatory dispensations. These measures provide temporary relief, not a permanent solution.

The real challenge is to restore a more sustainable balance between credit growth and resource mobilisation. That requires stronger deposit franchises, sharper liquidity forecasting, closer monitoring of contingent liabilities and a more integrated approach to balance-sheet management.

Banks often focus on pricing when deposit growth slows, but customer service matters just as much. Speed of service, responsiveness and efficient grievance resolution remain critical to retaining depositors. In the long run, a stable deposit base is built as much on trust as on interest rates.

The present credit cycle is exposing weaknesses in funding structures across the banking system. Banks that use this period to strengthen their liability franchises and sharpen ALM practices will be better placed to sustain growth without taking on excessive liquidity risk.